Question

Using the Altman’s Original Z-Score Model, if the calculated Z-score for a publicly traded company is 1.57, what can you conclude?

Answer 1

Altman's Original Z-Score Model defines a pubilcly traded company's tendency to go bankrupt. It is basically the output of a credit strength test that interprets the probability of a company to go bankrupt. It is based on 5 financial ratios that can be found from company's annual 10k report. The Z-Score basically uses leverage, profitability, liquidity, solvency and activity ratios to predict whether a company has high risk of being insolvent.

The Altman Z-score is calculated as follows:

Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

Where:

A = working capital / total assets

B = retained earnings / total assets

C = earnings before interest and tax / total assets

D = market value of equity / total liabilities

E = sales / total assets

A score below 1.8 means the company is probably headed for bankruptcy, while companies with scores above 3 are not likely to go bankrupt. Investors can use Altman Z-scores to determine whether they should buy or sell a particular stock if they're concerned about the underlying company's financial strength. Investors may consider purchasing a stock if its Altman Z-Score value is closer to 3 and selling or shorting a stock if the value is closer to 1.8.
Hence, from the question, if the calculated Z-score for a publicly traded company is 1.57 then the company is probably heading for bankruptcy and the stocks should be shorted.