What is the 'Altman ZScore'
The Altman Zscore is the output of a creditstrength test that gauges a publicly traded manufacturing company's likelihood of bankruptcy. The Altman Zscore is based on five financial ratios that can be calculated from data found on a company's annual 10K report. It uses profitability, leverage, liquidity, solvency and activity to predict whether a company has a high degree of probability of being insolvent.
BREAKING DOWN 'Altman ZScore'
The Altman Zscore is calculated as follows:ZScore = 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
NYU Stern Finance Professor Edward Altman, developed the Altman Zscore formula in 1967, and it was published in 1968. In 2012, he released an updated version called the Altman Zscore Plus that can be used to evaluate public and private companies, manufacturing and nonmanufacturing companies, and U.S. and nonU.S. companies. The Altman Zscore Plus can be used to evaluate corporate credit risk.
Altman ZScore Interpretation
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 Zscores 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 ZScore value is closer to 3 and selling or shorting a stock if the value is closer to 1.8.
Altman ZScores and the Financial Crisis
In 2007, the credit ratings of specific assetrelated securities had been rated higher than they should have been. The Altman Zscore indicated that the companies' risks were increasing significantly and may have been heading for bankruptcy.
Altman calculated that the median Altman Zscore of companies in 2007 was 1.81. These companies' credit ratings were equivalent to B. This indicated that 50% of the firms should have been rated lower, and they were highly distressed and had a high probability of becoming bankrupt.
Altman's calculations led him to believe that a crisis would occur and there would be a meltdown in the credit market. Altman believed the crisis would stem from corporate defaults, but the meltdown began with mortgagebacked securities (MBS). However, corporations soon defaulted in 2009 at the secondhighest rate in history.

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