Q ratio definition
/What is the Q Ratio?
The Q ratio compares a company's market value to the total value of its assets. When the ratio of market value to assets is less than one, a company's shares are considered undervalued. When the ratio is higher than one, a company's shares are fully valued to overvalued. Also, a high ratio indicates that a business is earning an above-average return, so it can expect increased competition. The concept is based on the belief that a company should be worth what it would cost to replace the business.
How to Calculate the Q Ratio
The Q ratio is calculated as the market value of a company's debt and equity, divided by the replacement cost of its assets. The formula is:
Market value of outstanding debt and equity ÷ Replacement cost of assets = Q ratio
Example of the Q Ratio
A business has 1,000,000 shares of common stock outstanding, which currently sell on a stock exchange for $6 each. The replacement value of its assets is $4,000,000. The calculation of its Q ratio is:
(1,000,000 shares x $6/share) ÷ $4,000,000 replacement cost
= 1.5 Q ratio
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Problems with the Q Ratio
The obvious problem with this ratio is the difficulty of arriving at a replacement cost for a company's assets, since this information is not reported in its financial statements. One might engage in a detailed analysis to derive this information, perhaps with the assistance of an asset valuation specialist, but doing so would be expensive. Another issue is that the ratio does not factor in the value of intangible assets, such as employees, training, customer loyalty, research and development activities, and branding.
Terms Similar to the Q Ratio
The Q ratio is also known as Tobin’s Q.