- NYU Professor Edward Altman created the “Z-Score” to track the likelihood of bankruptcy.
- More than 30 companies with over $1 billion in liabilities have filed for Chapter 11 this year.
- Z-Score trends suggest the number will top 60.
Another day, another bullish move for stocks. Behind the market numbers, a different set of headlines about corporate bankruptcies is quietly raising eyebrows.
Altman Z-Score Trends Suggest Stock Rally May Have Limits After All
The specific number being watched is the Altman Z-Score, created by Edward Altman of NYU. The Z-Score looks at a company’s credit strength rating, profitability, liquidity, and leverage, among others.
It divides companies up into a safety zone, a grey zone, or a distress zone.
Due to the pandemic, and a surge in corporate borrowing to meet the needs of that pandemic, stocks have been sliding to lower zones.
Bloomberg reports that corporations raised $2.1 trillion in bonds this year, with about half of that coming from the United States.
Corporate bond buying topped $2.1 trillion at the start of the year, providing immediate capital but increasing corporate leverage. | Source: Bloomberg
Over 30 big-name companies with over $1 billion in debt have already filed for Chapter 11 bankruptcy this year, and Altman sees that number doubling to 60 or more before the end of the year. As Altman sees the problem, “When there is an increase in insolvency risk, what you do not need is more debt. You need less debt.”
If Altman is right, corporate bankruptcies are on track for a ten-year high, in accordance with data compiled by Fitch Ratings.
Retail Investors May Add a Wild Card
So far, the stock market has shrugged off corporate bankruptcies that have occurred this year. Fears of bigger companies, like a major airline, faltering have likewise done little to slow the market’s advance from its March drop.
Part of the reason is retail investors. They’ve helped drive growth names far higher than they otherwise would have gone. Today’s retail traders have also been willing to pile capital into bankrupt companies.
Retail investors have been willing to buy shares of a company after they declare bankruptcy, creating massive jumps in companies likely to be wiped out. | Source: Bloomberg
In the case of car rental firm Hertz Global Holdings (NYSE:HTZ), retail traders raised the price so high that the company asked the bankruptcy court if it could issue more shares to raise capital. The court denied the request, as the company’s shares would essentially be worthless.
Retail traders have also asked the bankruptcy judge for assistance with their trade in bankrupt retailer J.C. Penney (OTC:JCPNQ).
If retail investors had been following the Altman Z-Score trends of these companies, they would have known to stay away from them rather than getting burned today.
This isn’t just mega-companies either. Altman predicts 192 bankruptcies in companies with at last $100 million in debt. That’s not as high as the 2009 peak (242), but it’s enough that any investor should tread extra carefully in the stock market right now.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com and should not be considered trading advice from CCN.com. The author holds no investment position in the above-mentioned securities.
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Author: Andrew Packer