Retail Companies Offer Strong Investment Opportunities

A study of Altman Z-scores, Part 2: High Z-scores tend to be reliable guides

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Jul 15, 2016
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Among companies trading on the Standard & Poor’s 500 index, several retail companies like Nike Inc. (NKE, Financial) had strong Altman Z-scores throughout their histories. With above-average Z-scores and historically strong business operations, these companies offer hot opportunities for investors.

A brief recap on Altman Z-scores

As mentioned in Part 1 of the study, the Altman Z-score measures the company’s stability based on its balance sheet. Companies with higher Z-scores are less likely to go bankrupt; according to Altman’s zones of discrimination, companies with a Z-score of at least 3.00 have little or no distress. Part 1 further divides the zones of discrimination into various distress levels. For example, companies with a Z-score between 5.00 and 7.99 have strong Z-scores, and companies whose Z-score is at least 8.00 have almost no distress.

More than half of S&P 500 companies have an Altman Z-score below 3, according to the distribution of current Z-scores. On the other hand, only 8.26% of S&P 500 companies have a Z-score of at least 8, and about 19% have a Z-score of at least 5.

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Historically high Z-scores lead to good investments

Since the minimum Z-score can determine if the company ever went into distress, it can further measure the strength of the company’s business operation. Currently, the distribution of minimum Altman Z-scores for S&P 500 companies has a mean of 1.45 and a standard deviation of 2.54. Most companies had a minimum Z-score of 1 or 2, suggesting that S&P 500 companies generally have experienced financial distress sometime during their histories. Only 17% of S&P 500 companies had a minimum Z-score of at least 3, i.e., never dropped out of safe zones. Such companies have stronger business operations because these S&P 500 companies likely survived the economic downturns of 2008 and 2011.

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Companies that have above-average scores, in addition to historically high Z-scores, offer good investing opportunities. Among the companies that always had Z-scores above 3, only 25 companies, including Nike, have current Z-scores above their median scores.

In addition to having strong Altman Z-scores, Nike has high interest coverage and returns on invested capital, suggesting that the footwear company has a strong business operation and high upward growth potential. Additionally, the company has expanding operating margins and consistent per share revenue growth, two good signs that signal value expansion.

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As the company’s operations expand, four gurus increased their positions in Nike during the first quarter. Pioneer Investments (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio) and Frank Sands (Trades, Portfolio) added 13.11%, 0.69% and 7.90% to their Nike position. Additionally, Steve Mandel (Trades, Portfolio), who currently owns 11,996,379 shares, raised his Nike position by 4.35%.

You can view the consensus picks of gurus and sector picks through the “Gurus” tab. Additionally, you can find hot retail companies using the All-in-one Guru screener. An earlier article discusses hot retail companies with high Piotroski F-scores.

Disclosure: The author currently has no position in Nike.

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