Business distress and bankruptcy can spell disappointment or even disaster for investors – and at a time of economic uncertainty, making that critical call between risk and reward is an increasingly challenging prospect. In the current environment investors ought to be scrutinising the financial health of their portfolio stocks and applying extra due diligence when it comes to new investments – but how? One excellent starting point is applying one of the longest running and best tested bankruptcy screening tools available to investors – the Altman Z-Score

Attempting to figure out which stocks are at risk of failure is nothing new in investment circles. However, getting to grips with the subject of quoted company failure is difficult because for every headline-grabbing disaster there are a number of others companies – often at the smaller end of the market – that simply fade away, leaving only the investors involved feeling battered and bruised. A classic example was the administration of stricken healthcare recruitment business Pinnacle Staffing Group this summer, which marked the sorry end to five years of underachievement and investor frustration. Back in September 2006, investors were given the option to buy in to the promising recruitment spin-out from health and social care services group Nestor Healthcare. It culminated in perpetual losses and Pinnacle’s remaining assets ultimately being sold off for just £17,000. Meanwhile, investors that stuck with Nestor did rather better when that company was sold earlier this year to private equity-backed Saga for £124 million. Financial distress or insolvency drove twenty-two companies to delist from the Alternative Investment Market during the first half of 2011, according to accountancy group UHY Hacker Young, although the figure dropped dramatically to just three companies in the third quarter – F.T.S.- Formula Telecom Solutions, Pinnacle Staffing and Agua Terra. Despite signs of improvement, industry-watchers are broadly agreed that economic conditions remain brutal and uncertain and that investors should be acting with care.

So how does an investor spot a company that might go under? The Altman Z-Score has been a part of the investor toolkit for more than 40 years but is not as well-known as it should be. It was developed by New York University finance professor, Edward I. Altman, who used a combination of five weighted business ratios to estimate the likelihood of financial distress. It was initially created to test the…

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