![]() The Altman Z-Score combines several important ratios into a single metric that provides valuable information about the financial health of a company. Using Z-Score to Improve Your Investment Screening Sales/Total Assets is left out of this formula since it is used for non-manufacturers. Z2 – Score For Non-Manufacturers & Emerging Markets Z-Score of over 2.9 represents a company with a safe balance sheet. Z-Score between 1.23 and 2.9 represents the “caution” zone. Z-Score of < 1.23 represents a company in distress. 42(D) + 1.0(E)Ĭ= Earnings Before Interest & Taxes (EBIT) / Total Assets (measures how much profit the firm’s assets are producing)ĭ= Book Value of Equity / Total liabilities (substitutes BV instead of market value for private companies)Į= Sales / Total Assets (efficiency ratio – measures how much the companies assets are producing in sales). Altman later developed revised versions: Z1-Score – Score for Private Firms First the Z-Score does not work with private, financial, or foreign companies. There are limitations which should be kept in mind. This makes the Altman Z-Score a great tool to quickly screen the health of a balance sheet. Stocks of companies with weak balance sheets underperform the market more often than not. Other studies show that there is great value in evaluating the strength of balance sheets. In other words, the formula provides high confidence probabilities but not certainty. It does this with a small percentage of false positives. Studies show that the Z-Score is able to predict 80-90% of bankruptcies 1 year prior to the fact. Predicting Financial Distress of Companies: Revisiting the Z-Score and Zeta Models 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:Īltman Z-Score Calculator 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 Liabilities) / 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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