On the other hand, companies whose Z-score is at least 3.0 are in safe zones.Īltman's classification of companies is broad as there are only three classifications. Such companies have an Altman Z-score less than 1.81, the threshold for distressed companies. Companies with low Z-scores are usually unstable and likely to go bankrupt. Based on the output, Altman classifies companies as safe, in gray areas or in distress. The company's net sales over total assets (S/TA).Īfter calculating these ratios, Altman inputs them into his five-variable model to compute the Z-score of the company. The market value of equity divided by the book value of total liabilities (MVE/BVL). The ratio of retained earnings to total assets (RE/TA). The company's working capital divided by the total assets (WC/TA). To calculate the score, Altman first computes the following five ratios: Click here to check it out.īased on five ratios calculated from the company's balance sheet, the Altman Z-score generates one value that measures the stability of the company. Warning! GuruFocus has detected 3 Warning Signs with GS. Based on the distribution of Z-scores for Standard & Poor's 500 companies, technological companies have the strongest scores, implying a strong and stable business operation. Unlike the Piotroski F-score, which only ranges from 0 to 9, the Altman Z-score can potentially be any real number. Cap.Developed by NYU Stern financial economist Edward Altman, the Altman Z-score predicts the likelihood of a company of going bankrupt within a two-year period. Predicting Financial Distress of Companies: Revisiting the Z-Score and Zeta Models The Altman Z-Score Formulaĭ= Market Value of Equity (Mkt. Recently, he has produced updated versions for private companies, non-manufacturing companies, and emerging markets companies (see below).įor those interested in really delving into the subject, here is his 2000 Research Paper: Here is a Z-Score calculator for those who want to figure the calculation directly from company financials: History of the Altman Z-ScoreĮdward Altman was a NYU Stern Finance Professor in 1968 when he developed the original Z-Score. The Altman Z-Score has become popular enough to be found in most data services such as Y-Charts. Z-Score of over 3.0 represents a company with a safe balance sheet. Z-Score between 1.81 and 2.99 represents the “caution” zone. Z-Score of < 1.81 represents a company in distress. + Preferred Stock) / Total Liabilities (compares the company’s value versus it’s liabilities)Į= Sales / Total Assets (efficiency ratio – measures how much the company’s assets are producing in sales). Z-Score = 1.2(A) + 1.4(B) + 3.3(C) + 0.6(D) + 1.0(E)Ī = Working Capital (Current Assets – Current Assets) / Total Assets (Measures liquidity of firm)ī= Retained Earnings / Total Assets (measures accumulated profits compared to assets)Ĭ= Earnings Before Interest & Taxes (EBIT) / Total Assets (measures how much profit the firms assets are producing)ĭ= Market Value of Equity (Mkt. The original formula was created for publicly traded manufacturing companies. If I had used the Altman Z-Score, which was warning of an impending bankruptcy, I would have avoided a total loss. ![]() I was a value investor! I waited until it got down to $5! But does it really matter? I still lost 100% of my money on that investment. I learned this lesson the hard way in 2000 when I bought Enron. Sure it might fall to $50, or even $40, but it will most likely not approach zero unless the company is headed for bankruptcy. It is highly unlikely you will lose a lot of money on this purchase, unless, the company goes bankrupt. If you buy an asset with an intrinsic value of $100 for $60 you have a large margin of safety. There are two easy ways to subject yourself to possible large losses buy stocks for more than they’re worth, and buy stocks of companies that go bankrupt. In particular, it is a probabilistic model to screen for bankruptcy risk of a company.Īs value investors, one of our most important rules is to avoid incurring large losses. The Altman Z-Score is a formula of 5 basic financial ratios to help determine the financial health of a company.
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