Altman Z-Score
The Altman Z-Score is a composite of five financial ratios that estimates the probability of bankruptcy within two years. Built by Edward Altman in 1968 for manufacturers, it weighs working capital, retained earnings, operating profit, market value of equity, and sales, each scaled against total assets or liabilities.
The math
Each ratio carries a fixed weight, and the weighted sum is the score. Take a struggling firm’s five inputs:
| Ratio | Weight | Struggling firm |
|---|---|---|
| Working capital / total assets | 1.2 | 0.05 |
| Retained earnings / total assets | 1.4 | 0.10 |
| EBIT / total assets | 3.3 | 0.06 |
| Market equity / total liabilities | 0.6 | 0.50 |
| Sales / total assets | 1.0 | 0.90 |
The weighted sum produces a Z of 1.60, inside the distress zone below 1.81.
The dollar consequence is blunt: equity holders stand last in a bankruptcy and typically recover nothing. A $30,000 position bought at 0.4 times book value can still go to zero, because cheap and safe are different words.
The trap
Buying statistical bargains without the solvency check. Deep-value screens fill up with stocks that are cheap precisely because the market doubts survival, and a low price-to-book paired with a Z below 1.8 is often the market being right.
The score also misleads outside its native habitat: banks, insurers, and asset-light service firms need different tools entirely.
The move
Run the Z-Score on every deep-value candidate before anything else. Above 3, move on to the interesting questions; between 1.81 and 3, read the debt maturity schedule and covenant terms; below 1.81, demand a specific, funded path to survival or pass.
Track the score’s direction across several years as well, since steady deterioration warns earlier than any single reading ever will.