Tuesday, April 8, 2014

"A heuristic for solvency analysis of non-financials"

This idea by Hui does seem like a better model than Altman.

In a recession, the combination of high operating risk and excessive leverage combine to produce insolvency for non-financial company. A better way of forecasting solvency risk is to look for companies that show:

High operating risk: The top two deciles of standard deviation of EBIT or EBITDA margin over the last 5 or 10 years (pick your horizon)
High financial leverage: The top two deciles of financial leverage, by total debt to market equity or interest coverage. Normalized decile scores by sector.

I have found that this heuristic, or simple rule of thumb, serves as a better forecaster of solvency risk as it neutralizes many of the industry specific effects that Altman Z failed to address.

1 comment:

Nathan said...

CP, did you see this story about Chinese trust products? Seems to support the Batesian mimicry theory of business cycles.

It looks even more real if you search for the project online in Chinese. In July 2012, Xinhua reported the investment "by Fortune 500 corporation Korea Hyundai Group".

In the official media of Hebei province, where the project is located, there have been lots of reports and pictures of the investment. Among them is the Hebei government making Hyundai RNC's chairman an "honorary citizen".

On YouTube, a video shows Hebei officials meeting some Koreans who are said to be key Hyundai personnel. There is also a website for the project, which is described as an investment of Hyundai E&C.

Yet, when George (who is in the financial industry) searched for the project in English, it was a completely different story. There is no mention of the project or Hyundai RNC on any of Hyundai's official websites or in any of its publications.

George found the Hyundai RNC website, where family links led to a Japanese adult-entertainment platform and two fashion sites. The website has recently been closed down.

So is it a Hyundai project or not? Money Matters decided to contact all the parties involved.

Hyundai E&C spokesman Son Chang-sung said: "Hyundai RNC is not a subsidiary of Hyundai E&C. The Hebei Auto City is not an investment by us. Nor have any of our officials visited the project."