What is a Zeta Score?

By Michael Thorburn

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In investing, zeta scores are used as a measure of variability and are used by investors and traders to help identify market volatility.

A zeta score or ‘Z-score’ is a numerical measurement that shows a value’s relationship to the mean of a group of values. Zeta score is measured in terms of standard deviations from the mean. In investing, zeta scores are used as a measure of variability and are used by investors and traders to help identify market volatility.

How a zeta score works

Calculating the zeta score can help to determine the financial position of a company and provides investors with an indication of the overall financial health of a company. Knowing a company’s zeta score can help investors make informed decisions about whether or not to invest in a company.

Typically, a zeta score of below 1.8 indicates that a company is close to bankruptcy whereas a score of 3 or higher suggests a company is in a solid financial position and therefore could be a sound investment opportunity.

The zeta score is based on five key financial ratios and analysts and investors can calculate a company’s zeta score from their annual 10-K report. Developed by a professor at New York University, Edward Altman introduced the zeta score in the late 1960s. It is also known as the Altman Z-score and can also be used to calculate credit risk.

The formula to calculate the Altman Z-score is: 1.2*A + 1.4*B + 3.3*C + 0.6*D + 1.0*E. Each letter represents a key piece of financial information about the company as follows:

  • A = working capital / total assets

  • B = retained earnings / total assets

  • C = earnings before interest and tax / total assets

  • D = market value of equity / total liabilities

  • E = sales / total assets

What else do you need to know?

Informing investment decisions

Financial analysts and investors can calculate a company’s zeta score or Altman Z-score to decide whether they should invest in the company (when the company has a zeta score of 3 or more) or whether they should sell or short stock (when the zeta score is 1.8 or below).

Provides an overview of the company’s financial health

Calculating the zeta score of a company can give investors a clearer view of the company’s overall financial health and can help analysts predict future events. For example, in 2007 the median Altman Z-score of companies was 1.81, which showed a high probability of bankruptcy and indicated that a financial crisis would occur.

Not immune to false accounting practices

As the zeta score of a company is calculated using the financial information found in the company’s annual 10-K report, it is only as accurate as the data it uses. If the financial information on the report has been falsified or is inaccurate then the accuracy of the zeta score will also be brought into question.

Difficult to measure new companies

New companies with little to no earnings will have a low zeta score which could falsely show that the company is close to bankruptcy, when in fact it just isn’t established yet. This makes the zeta score an unreliable measure for new companies.

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Author: Michael Thorburn

This article does not provide any financial advice and is not a recommendation to deal in any securities or product. Investments may fall in value and an investor may lose some or all of their investment. Past performance is not an indicator of future performance.