The equilibrium value of both Tobin’s q and the equity q can be based on historical long-run average values that could be greater or less than 1. In the absence of any information the equilibrium value of both Tobin’s q and the equity q is assumed to be 1.0.

Tobin’s q compares the current market value of a company to the replacement cost of its assets. The thinking is that the sum of the replacement values of the individual assets should be the same as their aggregate market value, as reflected in the sum of the market values of the firm’s debt and equity. The theoretical value of Tobin’s q is 1.0. If the current Tobin’s q is above (below) 1.0 the firm’s stock is presumed to be overpriced (underpriced).

The equity q focuses on equity values. It compares the aggregate market value of the firm’s equity to the market value of the firm’s net worth (i.e., net assets) measured as the market value of its assets less the market value of its liabilities. Again, the expected value of the ratio is 1.0.

Both ratios are considered mean-reverting. A q value above 1.0 would be expected to fall because it indicates that the firm’s net assets, as measured by the market value of equity, are currently overvalued. Using the opposite argument, a value less than 1.0 would be expected to rise.