Q Ratio Analysis for Global Powers

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As the global equity markets recover, so too have the Q ratios of the world’s leading publicly held retailers. This allows for a more robust analysis of the numbers. First, however, a brief explanation of the Q ratio is in order.

The Q ratio is the ratio of a publicly traded company’s market capitalization to the value of its tangible assets. If this ratio is greater than 1, it means that the financial markets are valuing a company’s non-tangible assets (brand equity, differentiation, innovation, customer experience, market dominance, customer loyalty and skillful execution). The higher the Q ratio, the greater share of a company’s value that stems from such non-tangibles. A Q ratio less than 1 indicates failure to generate value on the basis of non-tangible assets -- that the financial markets view a retailer’s strategy as being unable to generate a sufficient return on physical assets. Indeed, it suggests an arbitrage opportunity – that the company could be purchased through equity markets and the tangible assets subsequently sold at a profit.

Why is this important? In the current and anticipated business environment, the world’s leading retailers will face intense competition, slow growth in major developed markets and rising input prices, as well as consumer resistance to higher retail prices and excess retail capacity in many developed markets. Therefore, in order for retailers to succeed, they will have to find ways to distinguish themselves from competitors. That means having strong brand identity, offering consumers a positive shopping experience and being clearly differentiated from competitors. This can entail featuring merchandise offerings that include private brands, unique store formats and designs and unusual customer experiences. The goal is to have a sufficiently unique position in the market to generate pricing power and, consequently, strong profitability. If a publicly traded retailer has these characteristics, the financial markets are likely to reward it with a high Q ratio.

Which companies have high Qs? Many of the retailers with the highest Q ratios have been at or near the top of our list for several years in a row. These include Apple, fashion retailers Hennes & Mauritz and Uniqlo and online retailer Amazon.com. These retailers and others have strong brand identity, a unique market position and a reputation for executing their strategies with skill.

This year, there are 145 companies on our Q ratio list (compared with 144 in 2009 and 146 in 2008). The Q ratio was calculated using market capitalization as of November 16, 2009 and using total assets for the most recent fiscal year available. The composite Q ratio for all the companies on the list was 1.033, up from 0.745 last year, and the increase largely reflects the partial recovery of global equity markets during 2009.

Highlights The composite Q ratio was calculated for each of the major countries that host the world’s leading retailers. Interestingly, the highest composite Q ratio belongs to those retailers based in emerging markets, with a composite of 1.384 (retailers based in the United States had a composite Q ratio of 1.337). As was the case in the past few years, the country with the lowest composite Q ratio is Japan. Again, this likely reflects depressed equity prices as well as poor performance and failure to differentiate on the part of many leading Japanese companies, and there are some very strong Japanese retailers: The fourth-highest Q ratio belongs to Japan-based Fast Retailing.

Composite Q ratios also were calculated based on dominant merchandise category and format. The category with the highest composite Q ratio is hardlines. In part, this reflects the very high Q ratios of a handful of major players, including Amazon.com and Apple, both of which have played a significant role in the emergence of new technologies. The fashion category, as usual, also has a high Q ratio. This reflects the strength of global specialty fashion chains like Hennes & Mauritz, Fast Retailing and Inditex – as well as the strength of discount fashion retailers (like TJX Companies and Ross Stores) in a difficult economic environment. Finally, and not surprisingly, the category with the lowest Q ratio is diversified retailers. This is consistent with past experience and may reflect problems that arise in poorly focused organizations.

The dominant formats with the highest Q ratio are electronics and apparel/footwear; in both cases, there are some notable, global giants with very strong brand identity and clear differentiation. Supermarkets and discount stores have Q ratios above 1; most other formats, however, have composite Q ratios lower than 1.