(LON:MRW): have you checked these financial risks?

Prudent risk management policies are often what separates a good investor from a great one. Luckily it is not as hard as you might think to upgrade your risk management systems - a humble checklist can be surprisingly effective. 

One of the most widely-cited financial safety checklists, called the Altman Z-Score, was found to be 80-90% accurate in predicting bankruptcy one year before the event in the 31 years up until 1999. This score measures the degree to which a stock resembles companies that have gone out of business in the past.

What it says about UK grocer Wm Morrison Supermarkets (LON:MRW) might well be keeping the group’s chief financial officer, Trevor Strain, up at night - especially considering the group recently reported a 22% drop in full-year net income...

Does (LON:MRW) pass the Altman Z-score test?

The Altman Z-Score was developed by New York University finance professor and leading academic, Edward I. Altman. Interpreting the Z-Score is simple. Any Z-Score above 2.99 is considered to be a safe company, while those with a Z-Score of less than 1.8 have been shown to have a significant risk of financial distress within two years.

If we apply it to (LON:MRW) what do we get? A Z-Score of 1.43 - below the cut-off point that signals potential distress. Here is a snapshot of where exactly the company fails:

Using the Z-Score to protect your portfolio

Fund manager Anthony Bolton once said: "When I analysed the stocks that have lost me the most money, about two-thirds of the time it was due to weak balance sheets. You have to have your eyes open to the fact that if you are buying a company with a weak balance sheet and something changes, then that’s when you are going to be most exposed as a shareholder." Using the Z-Score to identify this type of stock seems like a smart way to avoid similar mistakes.

Morrison's weak Z-Score should serve as a reminder to investors to be aware of the risks they allow into their portfolios.

Next Steps

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