bankruptcy predictor rates roc poorly

From "Criterion" in The Australian today


FOR those wondering what corporate domino is likely to fall next -- or indeed what stocks are the genuine safe harbours -- here are some handy research findings from JP Morgan's quant bods.

The firm has adapted the so called Altman Z-Score -- a bankruptcy predictor dating back to 1968 -- to gauge the least and most vulnerable stocks in the main sectors. And surprises abound: who would have considered Centro Properties to be “safest'' of the property trusts?

The Altman Z score derives from weighting and combining five ratios: working capital to total assets, retained earnings to total assets, EBIT to total assets, market cap to total debt and revenue to total assets.

In its own tweaking, the firm has dropped the market cap measure, on the basis that being big alone does not offer protection from disaster (just ask Lehman Brothers, AIG, et al).

If a stock scores less than one, there's cause for concern. A score of 1-3 is reasonable while above 3 is considered healthy.

Some of the worst-ranked are indeed predictable: Babcock & Brown Power (score of 0.23), Babcock & Brown Capital (-0.2) and good ol' ABC Learning (0.59). But they're joined by Premier Investments (Just Group's new owner) in retailing (score of 0.12), Computershare in IT (1.78) and Transurban in infrastructure (-0.3)

Real shocks are the well-regarded Sonic Healthcare on 0.99, pay-TV operator Austar United (-0.53) and, in energy, Roc Oil (-0.3).

In the financial services sector, one would have assumed the Four Pillars or QBE Insurances would still prevail. But no, it's Kerr Nielsen hit-for-six fundie Platinum Asset Management, worth an impressive score of 7.2

By this stage, investors may well be scratching their heads. One possible explanation is that in most cases the “total assets'' denominator has been savaged by write downs -- which of course improves the ratio.

A word of warning on interpretation is that many of the supposed laggards are in sectors with universally good scores. Telstra may be the worst of the telcos, but it's score of 1.37 is still OK and not much different to Singapore Telecommunications' 1.64.

Centro Properties (0.93) tops the pops in the property trust sector, well ahead of venerable names such as Westfield (0.53) and CFS Retail Property Trust (0.34). But with such low scores the whole sector is considered vulnerable.

Altman Z is reputed to have been a reliable indicator of failure in the past, having predicted 72 per cent of US corporate bankruptcies two years before they went belly-up.

But like other prescriptive techniques such as charting, it doesn't take into account other variables such as the market's attitude towards a sector, or the management X factor.

JP Morgan's exec director for quant analysis, Thomas Reif, describes the technique as a torch to shine in the market's dark recesses. But he's the first to admit it shouldn't be used in isolation.

Criterion agrees that Altman-Z sure beats the dart board or -- more likely after this morning share rout -- -- a blind stampede out of a stock or sector.