LONDON -- You don't need me to tell you how the banking crash and recession have pushed many companies to the brink of bankruptcy. Shares such as the Barclays, HMV Group, and MAN Group have collapsed 80% or more since the credit crunch erupted, and with the future in Europe and the banking sector still far from certain, many more companies could be at risk of going the same way.
Like you, no doubt, I'm always keen to ensure my potential investments aren't about to go bust! Indeed, I'm convinced avoiding losers is just as important as picking winners in today's choppy market.
With all that in mind, I use something called a "Z-Score" to help me sidestep portfolio disasters. This Z-Score was developed in the 1960s and evaluates various financial ratios to provide an overall verdict on a company's strength. Effectively, the higher the number, the less likely the company is to go bust -- although, of course, this is best considered in the context of the Z-Score of its industry as a whole.
Generally speaking, a score greater than three suggests the company is in very good health, while a score below 1.8 indicates the possibility of the firm going under. The Z-Score is not perfect, and I would encourage you to read more details.
Today I'm assessing Royal Dutch Shell (ISE: RDSA.L) . Here are my Z-Score calculations:
Royal Dutch Shell
Working capital/total assets
Retained earnings/total assets
Market value of equity/total liabilities
This comparison looked at the full-year results for Shell ending Dec. 31, 2011, and compares the figures with the same reports for a number of rival firms, including BP and ExxonMobil.
Shell's Z-Score comes in slightly below the industry average but still well into "safe" territory, and it actually grew at a higher rate than that of the industry between 2010 and 2011, up 20% compared with an 18% industrywide improvement.
The majority of the difference between Shell and the average comes from the market-value-to-liabilities ratio, which is less than three-quarters of the industry's as a whole. This is on the back of a relatively low market value compared to some of its larger rivals, plus a similar level of liability to others in the sector, which may give cause for concern.
The company's best ratio is turnover to assets, showing that the firm is making good use of its assets to generate revenue. Again, this ratio actually grew at a higher rate for Shell than the industry, jumping 20% between 2010 and 2011, indicating the company has been outperforming the sector on this front.
So is Shell on the cusp of bankruptcy? It compares well to the industry average in almost all areas. It does have a similar level of liability to even some of the largest firms in the sector, which could be a problem over the long term. On the other hand, its market value is probably underpriced compared to some of its peers, which may offer a decent buying opportunity.
Importantly, the company has been able to make good use of its assets where it counts: generating revenue. It has even been able to improve on its efforts in this area, which is key for a company in a sector that is highly dependent on its physical assets, such as a diversified oil and gas producer and explorer. This may be another sign that Shell is doing something right, even if the market hasn't fully noticed it.
To answer the question of whether Shell could go bust: I seriously doubt it!
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The article Could Royal Dutch Shell Go Bust? originally appeared on Fool.com.
Karl does not own any of the shares mentioned in this article. The Motley Fool owns shares of ExxonMobil. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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