Tobin’s Q Flashing Green On Russia

May 23, 2014

A sometimes-forgotten, but time-tested, metric is telling investors that investing in Russia is making a lot of sense these days.

Russia and its aggressive foreign policy have dominated world news this year. Its stock market has taken a brutal beating yet again as investors flee and sanctions threaten to derail the economy.

One has to wonder: Is there value in Russian equities, or is this a value trap? Is this the bottom of a bear market from which a secular bull will spring one day, or is this just a stop on the way to annihilation?

To answer these questions, one must look through the dark political cloud created by Vladimir Putin’s actions in Ukraine and realize that in the end, investment results will be determined by lasting economic principals not by the charged emotions that are ruling at present.

While there’s no way to predict which way the market will go over the short term, there are some reliable indicators like “Tobin’s Q”—which we’ll explain in a minute—that point to the sensibility of putting capital into the Russian market. So let’s take a closer look.

In dollar terms, the Russian market is down almost 50 percent from the highs in 2011 (or down 60 percent from the peak in 2008). The price-to-earnings multiples of the following Russia-focused ETFs look extremely low in comparison to those of other countries:

Of course, this in itself is no reason to buy. After all, it may just reflect a further collapse in earnings to come.

Furthermore, using discounted cash flow/earnings or relative valuation models for an economy that’s threatened with exclusion from the international payment system and whose currency is about as stable as bitcoin, is a recipe for disaster, in my opinion.

What is more useful in these extreme cases are balance-sheet-based valuation models. Cash flow/ earnings models try to estimate business value by assessing the upside and, by definition, must rely on forward-looking estimates. In contrast, asset-based models incorporate existing data and focus on the downside to assure capital protection.

My favorite measure that provides a solid sense of an investment’s downside is an old ratio that seems to have been all but forgotten nowadays—Tobin’s Q.


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