The essence of value investing is buying stocks at less than their intrinsic value. Intrinsic value can be defined as future earnings, distributions and growth. Predicting or surmising intrinsic value is a problem as it is not easily measured or calculated. However, the chart above illustrates a slightly different way to measure value by comparing the total value of the prices of stocks with the corporate net worth of those same stocks. The theory, created by James Tobin in 1968, is that the stock market is undervalued when the prices of all the stocks are less than the replacement costs of its assets. In other words it is cheaper to buy than build. The market is overvalued if the prices of all the stocks are greater than the replacement costs of its assets (cheaper to build than buy). When the ratio is 1.0, the stock market value is equal to the value of the assets.
Fortunately the Federal Reserve provides data with which we can calculate this ratio. For the first time since 2002 the ratio is above 1.0 suggesting that the stock market is overvalued compared to the value of the assets in those same firms.