Friday, 26 August 2011

The Altman Z-score – Time for a Revival?

Following the deep recession we have endured and the market instability we are currently experiencing, it is perhaps an interesting time to revisit and review the Altman Z-score.

This measure was devised by Professor Edward Altman in the early 1960s as a way of screening publicly listed companies for bankruptcy risk. Although not full-proof, a success rate of circa 70% does suggest that this is a useful measure along with other research.

Altman suggested a set of five financial ratios (using Multiple Discriminant Analysis) that uses a statistical technique to score a company and thereby predict the company’s probability of failure.

Eight variables are used from the P&L statement and the Balance Sheet to produce five key ratios. These key ratios are then weighted to give the overall single number Z-score.

The five key ratios are: -

1) EBIT/Total Assets
2) Net Sales/Total Assets
3) Market Value of Equity/Total Liabilities
4) Working Capital/Total Assets
5) Retained Earnings/Total Assets

The weighting, in order of the above, are x 3.3, x 0.999, x 0.6, x 1.2 & x 1.4 respectively.

The Z-score = 1+2+3+4+5

A high Z-score of 3 or above indicates a low risk of financial failure and that the company is safe based upon these specific accounts.

A Z-score of 2.7 to 2.99 indicates “On Alert” – this is an area where an investor should exercise caution.

A Z-score of 1.8 to 2.7 indicates a good chance of the Company going bankrupt within 2 years of operations from the Balance Sheet date of the financial figures used.

A Z-score below 1.8 suggests that the possibility of financial collapse is very high.

As an investor then, you a looking for a high Z-score combined with a low p/e and a high yield. As with any measure, when used in isolation you may get skewed results; the power comes in combining the measure with other metrics to provide the most detailed position from the data available.

Wednesday, 10 August 2011

The Impact of the Looting and Lawlessness on Our Economy.

I have been appalled and disgusted by the looting, destruction of other people’s property & businesses and the violence that we have witnessed across the major cities in England over the last few days.

However it is portrayed, whether as a reaction to an incident in North London last week involving the police, or as a protest against the austerity measures imposed by the coalition government, I can’t reconcile in my brain how this is anything other than opportunistic criminality and lawlessness on the part of very youthful looters.

What concerns me, in addition to the obvious security and law & order issues, is what this will mean for the UK economy and business in general. First of all there will be the cost of the smashed up shops and streets to repair, then there will be the insurance claims for all the stock that has been stolen and the fixtures that have been destroyed (which will, no doubt, be swiftly followed by increased insurance premiums). Then, one has to wonder what effect this will have on third quarter GDP growth. The looted and burnt down shops will be out of action for some time. Also, to a large degree, will be the shopping areas of most major cities in England – after all, who wants to go shopping when there is the distinct possibility that you could get mugged or worse – in some areas it would appear that Dick Turpin and co have returned!!!

Why are we in such a position of lawlessness in England right now? I must admit to being somewhat exasperated at the “do gooders” on TV and radio trying to justify this criminal behaviour by telling us that these actions are as a result of the youth of today being bored and having nothing to do. Really? I don’t remember previous generations having several hundred TV channels to watch, computer games & consoles to play, mobile phones, MP3s, 3D cinema etc, etc. But what they do lack is imagination – and discipline!

It seems to me that standards have been relaxing in this country since the 1930s – sometimes through necessity such as in World War 2, sometimes through change such as when compulsory National Service was abolished in 1960, and sometimes through half-baked ideas that never worked i.e. the end of corporal punishment in schools, new age teaching methods of non-competitive sports (well we couldn’t have anyone losing – except that replicates what happens in the real world!!!) and the abolition of Grammar Schools. How frustrating it is to dress smartly and make an effort for a Saturday night at the theatre just to find that no one else bothered and they are all wearing jeans, t-shirts and trainers. We are left with a society containing a large proportion that has no recognition of authority and no respect for politicians, the police or teachers.

It has become easy for the lazy to blame the bankers and multi-national corporations for their woes, but what they easily forget are the jobs that are created by the banks and corporates, the employment that they provide, and therefore the taxes that are directly and indirectly generated by them for the treasury to pay for the services provided across the country for the entire population, and to pay for the benefits for those less fortunate in our society.

What this country needs are more people taking control of their own lives in a positive way, pursuing qualifications, getting better trained, becoming more employable and earning their own money and contributing to society – not taking other people’s property by opportunistically breaking in to and looting shops under the cover of hoods and masks as part of a gang!!!

Where will this end? Only time will tell. On the one hand, we could easily have anarchy and lawlessness spreading across every town in the land, destroying property, businesses, lives and the economy. Or, on the other, if the government gets a firm grip and allows the police the power to do their jobs properly (including water cannons, rubber bullets and the army if necessary), law and order can be restored to the streets of our green and (sometimes) pleasant land.

Either way, the cost to business, to the economy, to our country will be high. A cost we will all have to pay for, for some time to come. A cost we could have avoided if only the standards, morals and discipline that has stood our country well for so long, had been maintained.