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. Here are my Z-Score calculations:
Working Capital/Total Assets
Retained Earnings/Total Assets
Market Value of Equity/Total Liabilities
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!
- The art of unethical investing
- Even the rich are feeling the squeeze
- Will BP go bust?
- Check National Grid share price