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 Royal Bank of Scotland, Dixons Retail and Thomas Cook 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 just 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 taken in context of the Z-Score of its industry as a whole. Generally speaking, a score above 3 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 of course, and I would encourage to read more details.
Today I'm assessing Sainsbury's (ISE: SBRY.L) . Here are my Z-Score calculations:
Working capital/total assets
Retained earnings/total assets
Market value of equity/total liabilities
This comparison looked at the full-year results for Sainsbury's ending March 17, 2012, and compares the figures with similar reports for a number of rival firms, including Tesco and Morrison Supermarkets.
Although Sainsbury's Z-Score is still fairly strong at 2.86, it comes in around 11% lower than the industry average, and declined at a greater rate than the sector year-on-year; falling 6.5% compared to 3% industry wide.
The majority of this difference comes from the market value to liabilities ratio, which is around 60% of the industry's 1.34 average. In turn this comes predominately from a lower market value of equity than most of its peers, interestingly even lower than many smaller U.K. supermarkets.
The two areas where Sainsbury's outperforms the average slightly is in retained earnings to total assets and revenue to total assets. Sainsbury's numbers here conform very closely to those of the sector, and both ratios saw similar levels of decline or stagnation as the industry year-on-year.
In summary then, Sainsbury's really offers us nothing special as far as supermarkets are concerned. Its market value may be underpriced; its current P/E ratio around 9.8 certainly comes in below the industry average of 11. But away from this the company really seems to offers little above its peers.
Could Sainsbury's go bust? Well. I doubt it will happen anytime soon, but I would probably be careful about investing in it at a time when the U.K.'s economy is still seen as being on the rocks.
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The article Could Sainsbury's 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 Tesco. The Motley Fool has adisclosure policy.
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