Tobin’s Q Flashing Green On Russia

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

ETF specialist
Reviewed by: Boris Valentinov
Edited by: Boris Valentinov

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.


Tobin’s Q

First introduced by Nobel Prize winner James Tobin in the 1960s, the q ratio (aka Tobin’s Q) is simply the market value of all the firms in an economy divided by the replacement value of their assets. The basic idea behind it is the connection between financial assets and real assets—in an economy in equilibrium, their prices should be about equal (q ratio of 1). Let’s quickly review why that must be the case:

If companies were valued higher than what it takes to replicate them (q ratio > 1), financial actors—banks, venture capitalists, entrepreneurs, etc., would purchase assets, use them to form companies and then issue equity backed by these assets at a profit.

Over time, the increasing supply of financial assets would drive their prices down, while strong demand for real assets would boost their prices, until there is no profit in doing it. Importantly, this arbitrage process also works in reverse if companies were selling below the replacement value of their assets (q ratio < 1).

Unlike classic financial market arbitrage, however, by its very nature, this process can take years to bring about balance, and the disparity between equity prices and replacement value of assets can get quite large at times.

Nevertheless, the historical evidence is clear that the q ratio is mean reverting over the long term. In short: Tobin’s Q is no good for predicting the direction of the market in the short term, but in the end, its iron logic is inescapable.

This chart for the U.S. stock market going back to 1900 illustrates the point.

Tobin's Q converted


A quick look reveals that the q ratio stood between 0.3 and 0.5 during all bear market bottoms in the 20th century: 1921, 1932, 1949 and 1982. On the opposite side, it was almost 1.4 at the end of the roaring ’20s, and even higher (1.8) at the top of the Internet bubble in 2000. The current level for the U.S. stock market based on the latest Federal Reserve statistics is about 1.1.*

It’s important to point out a few things about the q ratio.

First, the ratio should only be used for the economy as a whole because it doesn’t have much meaning in the context of individual companies. That’s because it does not take into account the intangible assets of an enterprise: reputation with customers, intellectual capital, business processes, innovation capability, etc.

All of these are enormously important at the individual company level. However, at the level of the whole economy, these intangibles wash out, i.e., company A’s competitive advantage is company B’s competitive disadvantage.

Second, to avoid double counting, financial companies get excluded from the calculation since their assets consist primarily of claims on the assets of other economic entities.

Q Ratio Of The Russian Stock Market

Unlike the Federal Reserve, most central banks in emerging markets don’t publish the data needed to calculate the q ratio for their stock markets directly. So, to get a sense of what it might be for Russia, we must come up with a clever way to do it indirectly, allowing for some margin of error.

To accomplish this, I decided to use the iShares MSCI Russia Capped ETF (ERUS | C-94) as a proxy. I chose it because it aligns well with the makeup of the domestic economy—heavily weighted toward energy, financials and basic materials. With some adjustments, its P/B ratio can help us arrive at an acceptable estimate of the q ratio for the whole Russian market.

Based on data, the current P/B ratio for ERUS is 0.59. After excluding financials—they represent 16 percent of the portfolio—we get P/B ex-financials of 0.55.


Although P/B is different form Tobin’s Q for individual companies, at the level of the whole economy and in the absence of inflation/deflation, the two ratios start to converge. In cases where inflation is a consideration, replacement value is higher than reported book value (which is largely based on historical cost). How much higher is hard to say—it depends on the type of asset and the length of its useful life.

However, a very conservative estimate based on the recent high-single-digit inflation in Russia would put the replacement value at least 10 percent higher than reported book value. This would make the q ratio at least 10 percent lower than the above calculated P/B ratio (0.55). In other words, the q ratio of Russian equities is currently below 0.5.

So what does this mean? It means the Russian equity market as a whole is selling for half the replacement value of its assets. It means Tobin’s arbitrage process will work in reverse over the years ahead, bringing the price of stocks up to the equilibrium level and perhaps higher.

How will that happen? In some cases, weak companies will be liquidated and the proceeds distributed to shareholders. Other firms will be acquired. Yet others will manage to redeploy their assets to better uses. The important thing to realize is this: No matter what path the Russian market takes in the short term, the real assets that back these securities don’t go away.

The equipment, the infrastructure, the buildings, the natural resources, etc., owned by these companies offer a solid downside protection even in the worst economic scenario. The peace of mind this affords a long-term investor is essential to be able to stay the course regardless of market fluctuations, especially since the time frame over which prices of financial assets get back in line with prices of real assets is usually long and the discrepancy can grow even larger before reversing its course.

So if you’re searching for a quick trade, look elsewhere. For patient investors, though, this may be a once-in-a-lifetime opportunity to put some capital into Russia at ridiculously low prices and reap big potential rewards in the future.

To echo Jim Grant’s sentiment in a recent Bloomberg interview about Russia, remember: “This too will pass.”


*Q ratio for U.S. equities as of 12/31/13 based on “Flow of Funds Report, Balance Sheet of Nonfinancial Corporate Business,” page 114: line 36 - Market value of equities outstanding, divided by line 33 - net worth (market value) (

At the time this blog was written, the author held no positions in the securities mentioned. Contact Boris Valentinov at [email protected].


Boris Valentinov is an ETF specialist at He focuses on equity, currency and European-domiciled ETFs. Boris' previous experience includes a number of positions at various businesses within GE Capital. There, he analyzed corporate financial statements, evaluated market opportunities and developed business strategies in support of M&A activities and other investment decisions. Boris holds a B.A. in economics from Hamilton College, an M.S. in financial analysis from the University of San Francisco, and is a 2015 Level III candidate in the CFA program.