Accounting and Market based measures of performance

Accounting Based Measure PBIT/EBIT, PAT/Sales, EVA Market based measure Market Capitalization, MVA, Tobin s q

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Accounting and Market based measures of performance

Accounting-based measures capture historical performance while market-based measures capture future performance

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Accounting and Market based measures of performance

Accounting-based measures as an indicator of firm performance was challenged. Previous studies documented a weak association between reported earnings and stock returns, which led to arguments that the fundamental measurement process of our current accounting and reporting system distorted and adversely affected the informativeness of accounting-based information.
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Tobin s Q
Ratio - developed by James Tobin, 1969. Compares the value of the stocks of a company listed in the financial market with the value of a company's equity book value.

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Tobin s Q
Calculated by dividing the market value of a company by the replacement value of the book equity. Equity Market Value + Liabilities Book Value Equity Book Value + Liabilities Book Value

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Tobin s Q
Q also determines the valuation of the market as a whole. Q = Value of the stock market Corporate Net Worth Firms market value Book value of its assets
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Tobin s Q
Firms market value =sum of the market value of equity and book value of debt Mean of daily closing price of last quarter This price (Mean of daily closing price of last quarter) multiplied by the number of shares outstanding at the end of the year = the market value of equity of the firm.
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Tobin s Q
The book value of the equity = adding equity (share)capital and reserves (surplus, undistributed profits), and subtracting the revaluation reserve.

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Tobin s Q

Market capitalization+ Book Value of Total Debt Book Value of total assets

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Tobin s Q
Application
If the market value reflected solely the recorded assets of a company, Tobin's q would be 1.0. If Tobin's q is greater than 1.0, then the market value is greater than the value of the company's recorded assets. This suggests that the market value reflects some unmeasured or unrecorded assets of the company. High Tobin's q value encourages companies to invest more in capital because they are "worth" more than the price they paid for them.
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Tobin s Q
Application

Q= Market Value of the Installed capital Replacement Cost of Capital If a company's stock price (which is a measure of the company's capital market value) is Rs 2 and the price of the capital in the current market is Rs 1; the company can issue shares and with the revenue invest in capital. In this case q>1.
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Tobin s Q
Application

If Tobin's q is less than 1, the market value is less than the recorded value of the assets of the company. This suggests that the market may be undervaluing the company. Lang and Stulz, found out that diversified companies have a lower Q-ratio than focused firms because the market penalizes the value of the firm assets.
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Tobin s Q
Application

Tobin's discoveries show us that movements in stock prices will be reflected in changes in consumption and investment. Although empirical evidence reveals that his discoveries are not as tight as one would have thought. This is largely because firms do not blindly base investment decisions on movements in the stock price rather they examine the present value of expected profits and future interest rates.
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Tobin s Q
Variables
Tobin's q reflects a number of variables, and in particular: The recorded assets of the company. Market sentiment, reflecting, for example, analysts' views of the prospects for the company, or speculation such as bid rumors. The intellectual capital of the company.

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Tobin s Q
Tobin's marginal q

Tobin's marginal q is the ratio of the change in the value of the firm to the added capital cost for an increment to the capital stock

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Tobin s Q
P/B ratio

In inflationary time, Q will be lower than P/B ratio conversely it will be higher than Q. During periods of very high inflation, the book value would not reflect the cost of replacing a firm's assets, since the inflated prices of its assets would not be reflected on its balance sheet.

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