LONDON -- You don't need me to tell you how the banking crash and recession have pushed many companies to the brink of bankruptcy. Shares such as the Royal Bank of Scotland, Dixons Retail, and MAN Group have collapsed 80% or more since the credit crunch erupted, and with the future in Europe and the banking sector still far from certain, many more companies could be at risk of going the same way
Like you no doubt, I'm always keen to ensure my potential investments aren't just about to go bust! Indeed, I'm convinced avoiding losers is just as important as picking winners in today's choppy market.
With all that in mind, I use something called a Z-Score to help me sidestep portfolio disasters. This Z-Score was developed in the 1960s and evaluates various financial ratios to provide an overall verdict on a company's strength. Effectively the higher the number the less likely the company is to go bust, although of course this is best taken in context of the Z-Score of its industry as a whole. Generally speaking, a score above 3 suggests the company is in very good health, while a score below 1.8 indicates the possibility of the firm going under. The Z-Score is not perfect of course, and you might want to read more about the details.
Today I'm assessing National Grid (LSE: NG.L). Here are my Z-Score calculations:
|
Ratio |
National Grid |
Industry Average |
|---|---|---|
|
Z-Score |
1.85 |
1.61 |
|
Working Capital/Total Assets |
-0.05 |
-0.01 |
|
Retained Earnings/Total Assets |
0.28 |
0.11 |
|
EBIT/Total Assets |
0.05 |
0.05 |
|
Market Value of Equity/Total Liabilities |
2.02 |
1.11 |
|
Turnover/Total Assets |
0.15 |
0.64 |
This analysis looked at full-year results ending March 31, 2012, for major U.K. electricity and gas distribution companies, including United Utilities (LSE: UU.L) and SSE (LSE: SSE.L).
Although National Grid has a Z-Score of just 1.85, a low number is a general trend for this type of company, and 1.85 actually compares well to the industry average of 1.61. The majority of this strength comes from a higher market value than its competitors, which in turn stems from a large number of outstanding shares that have managed to hold their value.
Comparatively low levels of revenue and a large number of assets have the company's worst-performing ratio, turnover to total assets, at less than a quarter of the industry average. That said, a number of positive outliers may have skewed the mean level used here, and it should be noted that National Grid's number actually comes in at the median.
While the industry average Z-Score fell 1% year-on-year, that of National Grid increased from 1.76. That's a little over 5%, again mainly on the back of an increase in the company's market value. That said, the industry turnover to total asset level increased 19% from 0.54 the previous year, while that of National Grid held level at 0.15.
Although its revenue stream is weaker than some of its larger competitors, it still compares well to similar firms of its size. It has a strong market value and overall its financial strength would seem to be better than the industry average. More importantly, it has improved its position at a time when that of the sector as a whole weakened.
So could National Grid go bust? Well, things could be better, but they could be a lot worse!
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