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RATIOS & STATISTICS / ADVANCED
AltmanZOrig
Full Description

There are three versions of the Altman Z-Score. In all cases higher values are better, but the cutoffs vary. See the descriptions of each below

AltmanZOrig

Z = 1.2 * AltmanX1 + 1.4 * AltmanX2 + 3.3 * AltmanX3 + 0.6 * AltmanX4 + 1.0 * AltmanX5

Initially, Altman worked with a cutoff of 2.675; scores below that were presumed to signify significant bankruptcy risk. The probability of accuracy was very high in the percentage of bankruptcies it predicted, but at the cost of too many (in Altman?s judgment) Type II errors (flagging firms as distressed that do not wind up filing bankruptcy). Accordingly, Altman recommends use of a cutoff of 1.81.

AltmanZPriv

Z = .717 * AltmanX1 + .847 * AltmanX2 + 3.107 * AltmanX3 + 0.42 * AltmanX4Rev + .998 * AltmanX5

While privately-owned companies are not included in our database, we understand that we must necessarily depart from literal application of the model if we are to make it useful to assess stock prospects. Accordingly, users may want to consider this variation in cases where they believe the current market value of equity may be temporarily distorted and not indicative of the value the equity is likely to have over a longer term. Altman recommends use of a score of 1.23 or greater

AltmanZNonManu

Z = 6.56 * AltmanX1 + 3.26 * AltmanX2 + 6.72 * AltmanX3 + 1.05 * AltmanX4

Variables X1 through X4 are the same as in the original model. X5 is omitted in order to minimize potential industry effect, which can be troublesome as comparisons from one to another become less apples-to-apples. Altman recommends use of a cutoff score of 1.10.

Related Factors:

AltmanX1 AltmanX2 AltmanX3 AltmanX4 AltmanX5 AltmanX4Rev AltmanZ

Background

The Z-Score, created by Prof. Edward Altman, is a well-established model designed for and used to predict corporate bankruptcy at least a year in advance. Traditionally, as of the time Altman developed the model, credit analysis had been conducted mainly on a qualitative basis. And to the extent any quantitative work was done, the value of ratio analysis had been called into question by many in the academic community who favored more rigorous statistical techniques. Altman regarded the main innovations of his research as showing the value of ratio analysis and showing the value of an approach that used multiple factors in a single model, as opposed to the single-factor inquiries used by others who had been willing to work with ratios. It was created in the late 1960s based on multiple discriminant analysis conducted on a sample of 66 publicly traded companies, 33 of which had declared bankruptcy between 1946 and 33 of which did not. In selecting companies for the latter control sample, Altman aimed for a paired sample stratified by industry and size.

It was created in the late 1960s based on multiple discriminant analysis conducted on a sample of 66 publicly traded companies, 33 of which had declared bankruptcy between 1946 and 33 of which did not. In selecting companies for the latter control sample, Altman aimed for a paired sample stratified by industry and size.

IMPORTANT CAVEATS:

The Altman Z Score models have been noticed in the equity investment community and many seek to use this as part of the stock selection and analysis process. Accordingly, we are making it available. It is very important to note, however, that the model was developed for purposes of predicting bankruptcy. Equity returns, a critical dependent variable in the research of others who developed valuable models for use by equity investors, was not considered as part of Altman?s research. Equity investors who are interested in the Z score are necessarily presuming there is a relationship between bankruptcy and poor share price performance. In a big-picture sense, we can logically assume this is the case. But Altman did not research the timing and pace at which share price deterioration preceded bankruptcy. Note, too, that even within the area of bankruptcy prediction, Altman later came up with what he regarded as a superior model, a Zeta score. But because this was developed for a particular client and sold to them for their proprietary use, had has not divulged its parameters with enough specificity to be implemented by anyone except the client.

Accordingly, we cannot and do not suggest that your use of Z-score in the manner prescribed by Altman will enhance your strategy design. If you wish to work with Z score, consider using it in different ways (i.e. different score cutoffs and combinations with other criteria) and/or as a consideration in individual company analysis.