kcchongnz blog

Stock market tip: Avoid losing big from stock tips using Altman Z-Score kcchongnz

kcchongnz
Publish date: Tue, 04 Jun 2019, 09:13 PM
This a kcchongnz blog

This is a free tip in the stock market.

Rule No. 1: Never lose money

Rule No. 2: Never forget Rule No. 1

I have been reiterating that in investing, we must take care of the downside first before looking at the upside so that the chance of facing permanent loss of capital is slim. The permanent loss of capital can be split into three sets of risks: valuation risk, business/earnings risk, and balance sheet/financial risk.

Investors tend to ignore these risks when chasing stock tips, rumour and hot stocks, especially recommended by analysts, investment bankers, insiders and syndicates, famous investors, friends and relatives, and tooth fairies, and ended up losing big time in the stock market. If you have been one of them and have been reading and following some continuous touting of stocks in i3investors, you would agree with me, don’t you?

Here, I would like to introduce to you one effective way how to avoid this pitfall by doing some checking yourselves before  sinking your money in those stocks touted by other people as above, the use of the good old Altman’s Z-Score to measure the bankruptcy risk of a public listed company. Afterall, if a company bankrupt, or perceived to have high bankruptcy risk, there is where investors will lose big or all their investment in the stock of the company.

The Altman Z-Score was devised by Edward Altman, the New York University professor as a statistical tool used to measure the likelihood that a manufacturing company will go bankrupt. Though Altman devised the Z-Score in the 1960s, the notion of trying to predict which companies would fail was far from new at that time. However, Altman added a multivariate analysis to the mix of traditional ratio-analysis techniques such as current and quick ratio, and this allowed him to consider not only the effects of several ratios on the "predictiveness" of his bankruptcy model, but to consider how those ratios affected each other's usefulness in the model. The model has also been used successful for other types of companies, except for financial institutions.

Altman started out with 22 ratios classified into five categories; liquidity, profitability, leverage, solvency and activity. Over the years since its introduction, the Z-Score has been improved and eventually narrowed down to five ratios. It has become one among the reliable predictors of bankruptcy and many analysts nowadays use this method above any other because of its wide applications. In fact, once Altman re-evaluated his strategies by examining eighty-six distressed firms from 1969 to 1975 and then 110 bankrupt firms from 1976 to 1995 and later 120 bankrupt firms from 1996 to 1999. The Z-Score had an accuracy level of between 82% to 94%, which was more than that achieved by any of the methodologies that existed.

These five ratios are as below

X1 = (Net Working Capital / Total Assets).

X2 = (Retained Earnings / Total Assets).

X3 = (EBIT / Total Assets).

X4 = (Market Value of Equity / Total Liabilities).

X5 = (Sales / Total Assets).

The multivariate equation used is,

Z = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 1.0*X5.

The relevancy and predictability of the metrics used above are also intuitive, but I will not elaborate here. Here, we will just make use of the formula to evaluate one of my favorite stocks, Eversendai, just for illustration.

 

Z-score of Eversendai

From the latest annual report for year ended 31st December 2018, here are the information extracted.

Figures in thousands

 

Working capital

586068

Total assets

3276136

Retained earnings

206618

EBIT

123530

Market cap

323700

Book value of total liabilities

2305938

Sales

1705750

   

Price on 5th June 2019

0.415

No. of shares

780000

 

The computation of Altman Z-score is as followed,

X1 = Working Capital / Total Assets

0.17889

X2 = Retained Earnings / Total Assets

0.06307

X3 = Earnings before Interest and Taxes / Total Assets

0.03771

X4 = Market Value Equity / Book Value of Total Liabilities

0.14038

X5 = Sales / Total Assets

0.52066

Z

1.03228

 

The Interpretation of Altman Z-Score:

According to the interpretation of the Z-score from Altman’s multivariate analysis,

Z-SCORE greater than 3.0 –The Company is considered ‘Safe’ and has a negligible chance of getting to bankruptcy.

Z-SCORE between 2.99 and 1.23 – ‘On Alert’. This is in the “grey zone” area with moderate chance of bankruptcy and one should ‘Exercise Caution’.

Z-SCORE below 1.23- In “distress zone” area. Probability of Financial Catastrophe is Very High.

I hope you would be able to interpret the risk of investing in Eversendai based on this analysis.

The success in investing is not from constantly having multi-baggers in your stock investment, as investing is not that simple, and if it is so simple, everybody dabbling in the stock market will be filthy rich now, but to the contrary. On the other hand, if you can avoid losing big in potential bankrupt companies, you will do better than most players in the stock market. That is for sure. Start using this check if you are unsure if a stock tip you hear is worth investing.

Happy investing,

ckci3invest@gmail.com

Discussions
1 person likes this. Showing 50 of 84 comments

kcchongnz

King36,

I have not used this ratio before. Goggling it there is an academic paper by Beaver William. You may learn something from there.

Anyway, when you invest in good companies, which you should instead of speculating, you need not go through these kinds of checks, unless you are thinking of shorting stocks, which itself is even a more speculative endeavor.

2019-06-06 05:45

king36

Posted by kcchongnz > Jun 6, 2019 5:45 AM | Report Abuse

King36,

I have not used this ratio before. Goggling it there is an academic paper by Beaver William. You may learn something from there.

Anyway, when you invest in good companies, which you should instead of speculating, you need not go through these kinds of checks, unless you are thinking of shorting stocks, which itself is even a more speculative endeavor.


TQ, KC.
Its a pleasure to learn from you always.

2019-06-06 06:22

qqq3

kc...nothing worse than half tong water.....second worse is running fire enter devil.

in any case, its just a tool, a financial ratio,

kc.....................high Z scores....I would assume all cash rich companies have high z scores,
other companies with high z scores.......companies in matured industries, companies over the hill, companies worth more dead than alive, companies with lousy growth prospects, companies with Directors without ambitions, companies investors call value traps..........and prominently in last few years, red chips with manipulated accounts.



so, kc....how about a new category called Z score traps?

2019-06-06 10:42

Sslee

Hahahaha,
Pity poor qqq3, had not learns anything useful from his Buddhism study. Still hold tight to his past pain, resentment and animosity like a confusing young monk.

2019-06-06 11:00

qqq3

so ss....now u have a new category to play with ...its called z score traps............

2019-06-06 11:04

Sslee

Hahahaha,
Long ago already knew SENDAI is a Z score trap.

2019-06-06 11:12

qqq3

Buddhism very useful...........With Buddhism, meditation, can see things clearly, can be enlightened,

not deluded.

2019-06-06 11:49

BoPoint

Wonderful educational material by KC. Thumbs up for your write up. Z-score is a good indicator. Coupled with some logical analysis of whether a business is recurring/cyclical/project-based etc, one can start investing with good foundation.

2019-06-06 11:52

kcchongnz

Posted by qqq3 > Jun 6, 2019 1:12 AM | Report Abuse
kc.....................high Z scores....I would assume all cash rich companies have high z scores,
other companies with high z scores.......companies in matured industries, companies over the hill, companies worth more dead than alive, companies with lousy growth prospects, companies with Directors without ambitions, companies investors call value traps..........and prominently in last few years, red chips with manipulated accounts.


Hey ""Accountant"", look at the formula for Z-Score and those metrics used, which of your 7 categories of companies above fit the high Z-score you claimed to be? Name just one, not necessary all 7 and explain to justify if you have any common sense at all.

X1 = Working Capital / Total Assets
X2 = Retained Earnings / Total Assets
X3 = Earnings before Interest and Taxes / Total Assets
X4 = Market Value Equity / Book Value of Total Liabilities
X5 = Sales / Total Assets

Z = 1.20(X1) + 1.40 (X2) +3.30(X3) +.60(X4) + 1.0(X5)

2019-06-06 12:00

new_in_share

Dear KC Chong, thank for info. Can you tell where(web link) to get latest Bursa listed companies Altman Z-score. Again thanks in advance.

2019-06-06 12:09

new_in_share

Altman Z score is not static like share price right? It can be up or down depend on QR true?

2019-06-06 12:23

kcchongnz

Posted by new_in_share > Jun 6, 2019 12:09 PM | Report Abuse
Dear KC Chong, thank for info. Can you tell where(web link) to get latest Bursa listed companies Altman Z-score. Again thanks in advance.

Hi new_in_share,

I hardly use Altman z-Score as I always try to find good companies to invest in, as good companies always have very high Z-score because of their consistent earnings and healthy balance sheets.

You should do that too. But in case you need to check z-Score because someone tells you to buy a random stock, here is a link which I just found out. Courtesy of king36 in his comments in this thread.

https://www.isaham.my/stock/awc

2019-06-06 12:23

qqq3

by kcchongnz > Jun 6, 2019 12:00 PM | Report Abuse

X1 = Working Capital / Total Assets
X2 = Retained Earnings / Total Assets
X3 = Earnings before Interest and Taxes / Total Assets
X4 = Market Value Equity / Book Value of Total Liabilities
X5 = Sales / Total Assets
=================================
kc


chicken or egg? which comes first? good business or good scores?
what does one or two bad years do to all the scores? do the scores affect the business or the business affects the scores?

how good is it as a forecasting tool? assuming zero knowledge of the business.


investing is participating in the growth of excellent business. At the end of the day, it is still good business ( sense ), good management and good numbers in this order, not the other way round.

in the hands of people who are not ready, it is easily transformed into half tong water. Seeing the trees not the forest.

As Buddhist like to say, cause and effect.....but which is cause which is effect? chicken or egg?

and reliability of the tool?

2019-06-06 13:01

stockraider

Does it matter which come 1st ??

It is natural mah....a good business will attract a good score & bad business will attract a bad score loh...!!

Do not get confuse argue for sake of argue academically loh...!!

Posted by qqq3 > Jun 6, 2019 1:01 PM | Report Abuse

by kcchongnz > Jun 6, 2019 12:00 PM | Report Abuse

X1 = Working Capital / Total Assets
X2 = Retained Earnings / Total Assets
X3 = Earnings before Interest and Taxes / Total Assets
X4 = Market Value Equity / Book Value of Total Liabilities
X5 = Sales / Total Assets
=================================
kc


chicken or egg? which comes first? good business or good scores?
what does one or two bad years do to all the scores? do the scores affect the business or the business affects the scores?

how good is it as a forecasting tool? assuming zero knowledge of the business.


investing is participating in the growth of excellent business. At the end of the day, it is still good business ( sense ), good management and good numbers in this order, not the other way round.

in the hands of people who are not ready, it is easily transformed into half tong water. Seeing the trees not the forest.

As Buddhist like to say, cause and effect.....but which is cause which is effect? chicken or egg?

and reliability of the tool?

2019-06-06 13:07

qqq3

y stockraider > Jun 6, 2019 1:07 PM | Report Abuse

Does it matter which come 1st ??
============

your good friend OTB regularly keeps repeating the same mistakes ...OTB and his rear view drive has regularly produced disappointing results going forward......

so, I ask the same question...chicken or egg?

2019-06-06 13:11

stockraider

OTB is more successful than u loh....!!

U call that mistake ?? Raider don't loh.....!!

Posted by qqq3 > Jun 6, 2019 1:11 PM | Report Abuse

y stockraider > Jun 6, 2019 1:07 PM | Report Abuse

Does it matter which come 1st ??
============

your good friend OTB regularly keeps repeating the same mistakes ...OTB and his rear view drive has regularly produced disappointing results going forward......

so, I ask the same question...chicken or egg?

2019-06-06 13:20

qqq3

stockraider > Jun 6, 2019 1:20 PM | Report Abuse

OTB is more successful than u loh....!!
=======

what I know for sure is OTB is an image peddlar......

2019-06-06 13:21

stockraider

He is a good image....loh....!!


Posted by qqq3 > Jun 6, 2019 1:21 PM | Report Abuse

stockraider > Jun 6, 2019 1:20 PM | Report Abuse

OTB is more successful than u loh....!!
=======

what I know for sure is OTB is an image peddlar......

2019-06-06 13:25

qqq3

well, I guess his life depends on it.

2019-06-06 13:30

Sslee

Hahahaha,
People are now talking about AI and lab make meat you are still asking chicken and egg.

2019-06-06 13:37

qqq3

sslee

solving problems starts from defining a problem.....knowing cause and effect.......chicken or egg?

2019-06-06 13:45

Sslee

Hahahaha,
Agreed with you first statement "solving problems start from defining a problem" so have you define and found what are your problems?

2019-06-06 13:52

qqq3

sslee

I where got problems? I got no problem. I am happy and positive and needs no image peddling......I am self sufficient already.

2019-06-06 13:58

Sslee

Hahahaha,
Your problems is you do not have problems? A good first step to start with finding your problems.

2019-06-06 14:02

qqq3

no ambition then no problems la... it's really that simple. after all, how much can eat?

2019-06-06 14:47

Sslee

Hahahaha,
Qqq3, even enlighten Buddha also has problems in passing his truth teaching of non-attachment, freedom from impurities of mind and suffering to his followers. So how can we mortal human have no problems?

2019-06-06 15:12

witchslayer

Post removed.Why?

2019-06-06 15:13

qqq3

Sslee > Jun 6, 2019 3:12 PM | Report Abuse

Hahahaha,
Qqq3, even enlighten Buddha
==========

his problem is he want to be Buddha.....not my problem.....

2019-06-06 15:42

kcchongnz

Posted by qqq3 > Jun 5, 2019 6:32 PM | Report Abuse
kc...like I say, I am a pro....any thing also I do, good bad ugly also I do.......
but for novices, stick to quality, low turnover should be better than your value here, value there, Z score here, Z score there.


Z score here Z Score there?
You know what; when you were touting sailang and margin two years ago on Sendai, telling everyone to follow your sailang here sailang there, margin here margin there on Sendai, the Z-score then was already telling you a big red flag as below,

X1 = Working Capital / Total Assets 0.15734
X2 = Retained Earnings / Total Assets 0.01956
X3 = Earnings before Interest and Taxes / Total Assets -0.04723
X4 = Market Value Equity / Book Value of Total Liabilities 0.51650
X5 = Sales / Total Assets 0.53073
Z 0.90097

So was Z Score a good predictor on rubbish stock Sendai?

Absolutely!

2019-06-06 15:46

qqq3

kc.....the problem with Sendai is collection for the two tug boats.....if they had collected for the two tug boats, the situation is totally different.....

your z score here z score there knows the problem meh?

2019-06-06 16:02

Sslee

Hahahaha,
Qqq3 is a wily old fox, “no ambition then no problems la... it's really that simple” and his excuse “I am a pro....any thing also I do, good bad ugly also I do.......” cannot hide his ambition to be as rich as KYY when he reach his age nor exonerate his sins of sailang here sailang there, margin here margin there on Sendai and Jaks.

Even KYY was extremely impressed with qqq3’s “sailang” that he wrote an article to explain what is “sailang”? and his used of margin finance to maximize profit.
https://klse.i3investor.com/blogs/koonyewyinblog/166599.jsp

Not knowing that according to Uncensored Malaysia Dictionary: “Sailang” mean the act of stealing someone's lover

2019-06-06 16:27

kcchongnz

Posted by qqq3 > Jun 6, 2019 4:02 PM | Report Abuse
your z score here z score there knows the problem meh?

I don't know the problem? Do you know how many articles I have shared in i3investor alone on Sendai since two three years ago when you were shouting sailang here sailang there and margin here and margin there?

They all came with numerous comments of qqq, stockmanny, and maybe Desa6769, Lonranger, Brightsmart. Go back and read the threads and the silly comments you put up there.

2019-06-06 16:44

qqq3

kc...looking for short cuts don't work, not knowing cause from effect don't work, or worse giving wrong prescription for misdiagnosed problem.

2019-06-06 16:48

kcchongnz

Posted by qqq3 > Jun 6, 2019 4:02 PM | Report Abuse
kc.....the problem with Sendai is collection for the two tug boats.....if they had collected for the two tug boats, the situation is totally different.....

Are you sure Sendai build ""tug boat""? You asked people to sailang her sailang there, margin here margin there, but you don't even know what Sendai does? OMG!

But the nonpayment was precisely the balance sheet was bloated resulting its low Z Score. That is also how Z-Score can catch that there and useful in the assessment of its bankruptcy risk. Yes, you don't even have to know what Sendai does to know the big problem there.

By the way, can tell us why after so many years, the debts on your ""tug boat"" still not paid? Isn't that a big headed devil there? But with this big-headed devil, why did you pestered others to sailag here and sailang there, margin here and margin there?

2019-06-06 16:53

qqq3

kc


sendai...............40 sen to $ 1.40 between Sept 2016 and June 2017 also want to complain.....now back to 40 sen also want to complain......go buy Sendai lah.......I think its a good one at this price...sailang and margin if you want........

2019-06-06 17:05

kcchongnz

Posted by qqq3 > Jun 6, 2019 5:05 PM | Report Abuse
kc
sendai...............40 sen to $ 1.40 between Sept 2016 and June 2017 also want to complain.....now back to 40 sen also want to complain......go buy Sendai lah.......I think its a good one at this price...sailang and margin if you want........


But did you ask people to buy when it was 40 sen and then went up to RM1.40, or the other way round?

Ask me to sailang and margin Sendai now? Good advice. But please answer the question below first so that I can make an informed decision.

""By the way, can tell us why after so many years, the debts on your ""tug boat"" still not paid? Isn't that a big headed devil there? But with this big-headed devil, why did you pestered others to sailag here and sailang there, margin here and margin there?""

2019-06-06 17:11

qqq3

kc..a slight delay lah.....nevermind, its back to 40 sen now...good time to sailang and margin......

2019-06-06 17:14

Sslee

Hahahaha,
Qqq3 do not know what is a Liftboat from tugboat.
https://en.wikipedia.org/wiki/Liftboat
https://en.wikipedia.org/wiki/Tugboat

The below are what TSN said after 2018 AGM.
https://themalaysianreserve.com/2018/06/01/eversendai-to-resume-work-o...

Anyone attended the 29th May 2019 Sendai AGM, care to update what TSN promised?

2019-06-06 17:54

qqq3

its some kind of boat that took up $ 500 million in the balance sheet...........

2019-06-06 18:21

kcchongnz

Posted by qqq3 > Jun 6, 2019 6:21 PM | Report Abuse
its some kind of boat that took up $ 500 million in the balance sheet...........


The construction of the lift boats for the private company of the major shareholder of Sendai started some time in 2014, of which the first one completed last year and appears to have rented out and earning revenue for the private company. But they don't pay Sendai for over RM500m now and its balance sheet is so precarious that the company can go bankrupt any time now.

You have no concern at all having mst of your money in this company?

You still ask people to sailang here sailang there, margin here margin there?

What is your motive?

2019-06-06 18:40

qqq3

kc..............Tan Sri got 70% in Sendai.....Slight delay but Sendai will be paid......now 40 sen, best time to buy.

2019-06-06 19:39

stockraider

Post removed.Why?

2019-06-06 23:45

qqq3

stockraider > Jun 6, 2019 11:45 PM | Report Abuse

Like u say loh.."Stick to quality mah"...why in this case here, u talkcock leh ??
==========

stick to quality is good enough for the masses, for the layperson, but for experts like KcChong, he should get involved in Sendai for bigger rewards.

2019-06-06 23:49

paperplane

Altman-z, mana Ultraman-Z

2019-10-11 23:46

qqq3

ulta man got, u want ulta man?

2019-10-12 00:13

qqq3

what score lah....Armada from 15 sen to 40 sen.................

2019-10-12 00:15

qqq3

Jake from 50 to 90

2019-10-12 01:47

qqq3

Sendai a bit delayed.... maybe in a few months a different story

2019-10-12 01:49

kcchongnz

Posted by qqq3 > Oct 12, 2019 1:49 AM | Report Abuse
Sendai a bit delayed.... maybe in a few months a different story

What delay? When the following statements were made, Sendai was trading at RM1.20, it went down to 70 sen in 8 months for a loss of 42% while the market was booming.

[Posted by stockmanmy > Jul 7, 2017 11:25 AM | Report Abuse
Jaks and Sendai are for super investors...These super investors intend to make multiple baggers from Jaks and Sendai and already half way there.]

Again, when the following statement was made, Sendai dropped from 95 sen to close at 38.5 sen, for a loss of whopping 60% in two years.

[stockmanmy has left a new comment on your post "Margin Finance, Ever-Sendai: A real time case study kcchongnz": Sept 27 2017
sendai from 80 sen to 95 sen now...................
KC lousy timing, lousy business sense and lousy analysis.]

So where got delayed? Very fast indeed. What will happen to Sendai share price in a few months’ time, Stockmanny, qqq3, Brightsmart, Desa6769, Loneranger, etc.?

2019-10-12 08:52

paperplane

Kc, where got prove value investing woek in msia?? All goreng

2019-10-13 23:22

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