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Strategies & Market Trends : The Rational Analyst
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To: HeyRainier who wrote (1551)3/19/1999 3:54:00 AM
From: HeyRainier  Read Replies (1) of 1720
 
[ Bankruptcy Predictor: the Zeta Model ]

Speaking of forecasting ability, here's a look at something I ran into during one of my 'book raids' at the local bookstore:

It's a formula that has been derived from empirical research that attempts to predict the occurrence of bankruptcies. There were two forms given. One, the improved version, was held secret by the company that provides services based on the Zeta Model, and the other one is the basic formula.

Here it is:

Z = 1.2X(1) + 1.4X(2) + 3.3X(3) + 0.6X(4) + 1.0X(5)

Given the limitations of SI's word-processor, I have denoted the X(1) to mean "X sub 1" and so on. The following identify the various variables in the equation:

X(1) = 'Working Capital' to 'Total Assets'
X(2) = 'Cumulative Retained Earnings' to 'Total Assets'
X(3) = 'Earnings before interest & taxes' to Total Assets
X(4) = 'Market Value of Equity' to 'Book Value of Total Liabilities'
X(5) = 'Sales' to 'Total Assets'

Studies have found that whenever the 'Z' value fell below 1.81 (including the negative amounts), companies always went bankrupt, whereas companies with 'Z' values above 2.99 represented healthy firms. Anything in between fell into a gray zone.

Now the improved version, which did not have a disclosed formula, made modifications by including additional factors in their studies:

1. Return on Assets
2. Stability of Earnings
3. Interest Coverage Ratio
4. Retained earnings to Total Assets
5. Current Ratio
6. Common Equity to Total Capital
7. Size of Total Assets

What is incredible is that with the results, the model was able to predict up to a 96% rate of accuracy the bankruptcies that occurred within a year, and up to 70% rate five years before.

Now I wonder how Sunbeam will respond to this test...

RT
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