Applying The Altman Z-Score To Netflix And Amazon.com

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by: Paulo Santos

As requested in the comments on my article "Applying The Altman Z-Score To Sears", in this article I will perform the same exercise for Netflix (NASDAQ:NFLX) and Amazon.com (NASDAQ:AMZN).

First of all, for those that haven't read the previous article, the Altman Z-score as defined by Wikipedia:

The Z-score formula for predicting bankruptcy was published in 1968 by Edward I. Altman, who was, at the time, an Assistant Professor of Finance at New York University. The formula may be used to predict the probability that a firm will go into bankruptcy within two years. Z-scores are used to predict corporate defaults and an easy-to-calculate control measure for the financial distress status of companies in academic studies. The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company.

The Z-score is a linear combination of four or five common business ratios, weighted by coefficients. The coefficients were estimated by identifying a set of firms which had declared bankruptcy and then collecting a matched sample of firms which had survived, with matching by industry and approximate size (assets).

Inputs

The Z-score has 5 inputs:

T1 = Working Capital / Total Assets.

T2 = Retained Earnings / Total Assets.

T3 = Earnings Before Interest and Taxes / Total Assets.

T4 = Market Value of Equity / Book Value of Total Liabilities.

T5 = Sales / Total Assets.

Formula

Which then come together using the following formula:

Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5

Netflix

Now, down to business, the inputs for Netflix are as follows (source: latest NFLX 10-K):

Current assets: \$ 1831 million.

Current liabilities: \$ 1225 million.

Total assets: \$ 3069 million.

Retained earnings: \$ 423 million.

EBIT: \$ 376 million

Total liabilities: \$ 2426 million.

Revenues: \$ 3205 million.

Market capitalization: \$ 6340 million.

Using this data we get the following parcels:

1.2 * T1 = 0.237

1.4 * T2 = 0.193

3.3 * T3 = 0.404

0.6 * T4 = 1.568

0.999 * T5 = 1.043

This gives us a Netflix Altman Z-score of 3.45. We can thus conclude that, presently, there's no reason to doubt Netflix's solvability (source: Creditworthy.com):

3.0 or more,

Most likely safe based on the financial data. Of course, mismanagement, fraud, economic downturns, and other factors may cause an unexpected reversal.

Amazon.com

The inputs for Amazon.com are as follows (source: latest AMZN 10-K):

Current assets: \$ 17490 million.

Current liabilities: \$ 14896 million.

Total assets: \$ 25278 million.

Retained earnings: \$ 1955 million.

EBIT: \$ 862 million

Total liabilities: \$ 17521 million.

Revenues: \$ 48077 million.

Market capitalization: \$ 84420 million.

Using this data we get the following parcels:

1.2 * T1 = 0.123

1.4 * T2 = 0.108

3.3 * T3 = 0.113

0.6 * T4 = 2.891

0.999 * T5 = 1.900

This gives us an Amazon.com Altman Z-score of 5.13. This leads us to conclude that there's no reason to doubt Amazon.com's solvability:

3.0 or more,

Most likely safe based on the financial data. Of course, mismanagement, fraud, economic downturns, and other factors may cause an unexpected reversal.

Conclusion

Contrary to Sears (NASDAQ:SHLD), neither Netflix nor Amazon.com present any predictable solvency risk as per the Altman z-score. If there are reasons to short either of these stocks, those have to be found elsewhere (for instance, in Amazon.com's huge overvaluation and imploding margins).

Disclosure: I am short AMZN, SHLD.