Definition: The Altman Z-Score is a proprietary company score used by financial analysts and financial institutions to assess the likelihood of a company filing for bankruptcy. The company can be privately held or publicly traded.
A company’s Altman Z-Score is a key performance indicator used by investors, analysts, and analysts to evaluate a company’s financial health. The Z-Score is a five-category average that identifies the probability that an investor will purchase a stock at its current price. The categories include profitability, liquidity (defined as the ratio of debt to equity), leverage (defined as assets to debt), solvency, and activity. Companies with high likelihoods of default have high Altman scores; companies with low likelihoods have low Altman scores.
The higher the Z-Score, the better. An overall Altman score of 3 or better indicates strong overall credit standing and demonstrates a manageable level of risk. One should pay careful attention to how the score is calculated, as well as the factors considered.
Investors should consider Altman Z-scores when making investment decisions. The metric compares an investor’s expected future earnings against the company’s actual past performance. The higher the score, the better the investment. But investors shouldn’t pay too much attention to individual stocks because mixed performance stocks tend to move in opposite directions — sectors that perform strongly become less so, and vice versa.
The Altman Z-Score is based upon an analysis of publicly available information about a company’s financial performance. Each stock’s price is determined by measuring potential profits divided by total assets, meaning that stocks with low Z-Scores are undervalued, and stocks with high scores are overvalued. The higher the score, the better the investment for the average investor. However, investors need to remember that these scores are guidelines and always extra risky when investing in small-cap stocks because the number of profitable deals could be small.
Although stocks have to be bought and sold on an exchange, buying at these prices allows investors to participate meaningfully in the stock market without the risk of buying low and selling high.