Why Intercontinental Hotels' share price is at risk

Some very smart people have come up with proven checklists over the years that can drastically improve risk management with minimal effort. One of them was found to be:

• 72% accurate in predicting bankruptcy two years prior to the event in its initial test
• 80-90% accurate in predicting bankruptcy one year before the event in the 31 years up until 1999

I'm talking about the Altman Z-Score, which measures the degree to which a stock resembles companies that have gone bankrupt in the past. Clearly, avoiding the stocks this checklist highlights could save us a lot of pain in the long run. And what it says about Hotels & Entertainment Services operator 

Intercontinental Hotels (LON:IHG) might well be keeping the group’s chief financial officer, Paul Edgecliffe-Johnson, up at night...

Why IHG shareholders should know the Z-Score

The Altman Z-Score was developed by New York University finance professor and leading academic, Edward I. Altman. In 1968, the celebrated professor struck upon a combination of five weighted business ratios that is used by investment managers and hedge funds to this day.

Interpreting the Z-Score is simple. Any Z-Score above 2.99 is considered to be a safe company.

Those with a Z-Score of less than 1.8, on the other hand, have been shown to have a significant risk of financial distress within two years. As we mentioned earlier, numerous historical studies have shown the Z-Score to be an accurate predictor of imminent financial distress for those companies that score less than 1.8.

If we apply it to Intercontinental Hotels what do we get? A Z-Score of 1.20 - well below the cut-off point that signals potential distress...

Anthony Bolton, the well-regarded investment fund manager, 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 and avoid this type of stock seems like a smart way to manage risk.

Next Steps

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