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Valuing Wall Street

Contributed by mm | March 8, 2004 11:56 AM PST



I recently read the book Valuing Wall Street by Andrew Smithers and Stephen Wright.
The centerpiece of the book is the explanation and tets of q-ratio, a concept developed by Nobel Laureate James Tobin of Yale University. Q-ratio is defined as market value of assets divided by their replacement value. Conceptually, if market value far exceeds assets' replacement value, market force will create more companies instead of buying them on the public market, thus driving the price of the existing assets lower.

The book, published in March 2000, predicted a crash of the market by saying Dow can plummet to 4,000 or lower. The crash happened, but not to that extreme. However, according to the q-ratio tracker at Smither's site, S&P 500 was overvalued by 46% on June 20, 2003, when it was at 996. At yesterday's close of 1,058, it means an overvaluation of 55%. (The site also provides Excel download for q-ratio history.)

I am a firm believer that today's market is dangerously overvalued and am convinced of the q-ratio validity after reading the whole book. I have been taking a very defensive approach in my portfolio management since last summer and will continue to do so in the foreseeable future.

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