When looking at the probability of bankruptcy, you want to ensure there is a normalized z-score, which means you do not want the data to be too far from the mean, which is what the z-score measures. When looking at this data point, the probability of bankruptcy is a value between 0 and 100, which will tell you the probability of the company having financial distress in the next 2 years. This is very important to consider because you do not want to invest in a company that is potentially going under.
Taking it a little bit further, besides the obvious reasons of the company being worth nothing, you can use this tool to help you find value stocks. As alluded too, this is when you look for struggling companies, but the idea is that there is limited to no debt and the company has enough cash to survive the down times. Of course there are other factors, but that is why using the probability of bankruptcy in this scenario may prove useful.
This type of information is purely fundamental and should be used as such. When looking at charts, you may see a stocks price begin to tank and take on pressure, this is a prime time to take a look and run the probability of bankruptcy, to know in the near term if the business is going to viable. There are other items you would want to take a look at such as the executive’s comments and the tone of the room. Listen in on the conference calls and determine what everyone is saying, as this will give you the best feel of where the company is headed. Bankruptcy is a last resort due to the many implications it poses, but do know a company can come close to bankruptcy and still prove to be a winner.
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Nathan Young is a Senior Member of Macroaxis Editorial Board - US Equity Analysis. With years of experience in the financial sector, Nathan brings a diverse base of knowledge. Specifically, he has in-depth understanding of application of technical and fundamental analysis across different equity instruments. Utilizing SEC filings and technical indicators, Nathan provides a reputable analysis of companies trading in the United States.
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