It is very common for an investor to fall into trap which is, investing in the wrong company that may face bankruptcy. This is one of the red flag that an investor must at all cost to avoid buying this kind of company in stock market. Bankrupt by definition means, a person or company is unable to pay or settle outstanding debt. In the stock market case, when a company has the characteristics that the debt is beyond control, it will face bankrupt. We have seen company like Enron and World.com (biggest financial fraud in wall street history).
There's a way to detect it even before it happens. Edward Altman has developed a formula on how to predict bankruptcy. This formula will provide 80-90% accuracy that a company will bankrupt within 2 years. this formula is called as Altman Z-Score Analysis. NYU Stern Finance Professor, Edward Altman, developed the Altman Z-score formula in 1967. In 2012, he released an updated version called the Altman Z-score Plus, that can be used to evaluate both public and private companies, both manufacturing and non-manufacturing companies and both U.S. and non-U.S. companies. Investors can use Altman Z-scores to help determine whether they should buy or sell a particular stock if they're concerned about the underlying company's financial strength. The Altman Z-score Plus can be used to evaluate corporate credit risk.
In Malaysia, particularly, you should have avoided companies like Transmile, Kenmark, Repco etc even though the price went outrage without reason. You do not want to invest your hard earn or retirement money into these kind of companies.
Ok, below are the screenshots of Altman Z-score formula. The input of Z-score are derived from Balance Sheet and Profit & Loss Statement. Before you use this tool, make sure the source of inputs are available. If it is kept secret, you know the drill. they want to hide from you, there must be something fishy. There's a reason why all companies in all stock exchange around the world must release the quarterly/yearly reports.
- Altman Z-score Analysis
- Z-score
If you are interested in the above excel formula, do email me.
