The Altman Z-score was developed by New York University professor Edward I. Altman in 1968. An Altman Z-score is designed to reflect the probability of a corporate default over the course of the ensuing two years. Calculating a Z-score only requires plugging in common corporate income and balance sheet values, and has proven to be remarkably accurate. According to a recent Citi Research report authored by Markus Rosgen and Yue Hin Pong, the Altman Z-score “…has a rather better track record than many other metrics. In a study done up to 1999, the model was found to be 80-90% accurate in predicting bankruptcy one year before the event.”

Interpreting a Z-score

Altman Z -scores are interpreted based on theirdistribution into three ranges:

Z > 2.99 and the company is in the safe zone
Between 1.81 < Z < 2.99 and the company is in the grey zone
Anything below 1.8 and the company is in the distress zone

The grey and distress zones are defined differently for emerging markets. Between 1.22-2.9 puts you in the grey zone, and a Z-score below 1.22 puts you in the distress zone.

Current Altman Z-scores

Z-scores

Financial analysts use normalized stock index values instead of individual corporate values to assign Altman Z-scores to sectors or countries. Citi Research compiled Altman Z-scores on a global basis and offers the rather surprising results in their report published on January 30th.

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Not surprisingly, the U.S. has the highest Z-score, but many may be surprised by the fact that the EMEA came next, followed by Asia. Latin America, Europe and Japan had the lowest Z-scores, respectively. The aggregate numbers do not indicate any area is in the distress zone. Furthermore, the EM aggregate Z-score remains well above the numbers registered between 1995 to 2003 when multiples for EM were higher than today.

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The Citi report also points out that Indonesia, Mexico, South Africa have the highest Z-scores among the EM. Korea, China and Brazil come in on the next tier, but all three are still in the comfort zone and have minimal corporate default risk. The Z-scores for all other EM fall in the in the neutral zone.

On a valuation basis, Russia, Korea, HK, Poland and Thailand are all undervalued on a relative Z-score basis. The Philippines, India, Malaysia and South Africa, however, are all overvalued relative to their peers on a Z-score basis.