Business distress and bankruptcy can put a dent in your portfolio no matter how well diversified you are.
That's why paying attention to simple checklists that flag up risky stocks is so important. Stockopedia provides many of these screening tools to help investors safely navigate the stock markets. One of them - the Altman Z-Score - was found to be:
- 72% accurate in predicting bankruptcy two years prior to the event in its initial test
- 80-90% accurate in predicting bankruptcy one year before the event in the 31 years up until 1999
That's quite the vote of confidence. The Z-Score was developed by New York University finance professor and leading academic, Edward I. Altman. It measures how closely a firm resembles other firms that have filed for bankruptcy by considering the following areas:
- Current assets as a proportion of total assets,
- Cumulative profitability and use of leverage,
- Productivity of assets, and
- Firm value compared to liabilities
A Z-Score of more than 2.99 is considered to be a safe company. Those with a Z-Score of less than 1.8, on the other hand, have been shown to have a significant risk of financial distress within two years. We can see the checklist in action by applying it to a listed company. Take mid cap Drax (LON:DRX), for example.
How does Drax fare against Altman’s influential checklist?
What does the Altman Z-Score flag up about Drax?
Unfortunately, Drax fails Altman’s test, with a worryingly low Z-Score of 1.62...
Drax's low Z-Score doesn't mean that it is definitely heading for financial distress, but it does mean this fate is more of a risk for Drax than it is for most. To find more information, click here to load Drax's StockReport.
Fortify your portfolio with simple, effective tools
The problem areas for Drax identified here can be explored in more depth on Stockopedia's research platform. All the best investors have stringent due diligence processes that reduce the chances of them suffering big losses, so why not take a leaf out of their book?
Simple tools can help us better measure and understand the risks we take. That's why the Stockopedia team has been busy building new ways of understanding investment risks and company characteristics. In this webinar, we talk about two or our most popular innovations: StockRank Styles and RiskRatings. These indicators transform a ton of vital financial information into intuitive classifications, allowing you to get an instant feel for any company on any market - sign up for a free trial to see how your stocks stack up.