Altman Z-Score

The Altman Z-Score is a multi-factor model developed by Edward Altman in 1968 to predict corporate bankruptcy. It combines five financial ratios — working capital to total assets, retained earnings to total assets, EBIT to total assets, market value of equity to total liabilities, and sales to total assets — into a single composite, with empirically derived weights. Scores above 3.0 are the 'safe zone'; scores between 1.8 and 3.0 are the 'gray zone'; scores below 1.8 are the 'distress zone' historically associated with elevated bankruptcy probability within two years. The model was calibrated on manufacturing firms, so its absolute thresholds do not generalize cleanly to financials, REITs, or asset-light service businesses, where modified Z'' or similar variants apply. We use the Z-Score as a balance-sheet-stress flag for capital-intensive, non-financial businesses, particularly during cyclical downturns when leverage can rise and liquidity can compress simultaneously. A stock entering the gray zone triggers a balance-sheet drill-down; a stock entering the distress zone is generally disqualified from a buy rating regardless of valuation.