Aurora Borealis
1 November 1983 Financial Analysts Journal Volume 39, Issue 6

Predicting Bankruptcy: The Value Line Relative Financial Strength System vs. the Zeta® Bankruptcy Classification Approach

  1. Edward I. Altman
  2. Joseph Spivack

Both the Zeta® model of bankruptcy classification and the Value Line Relative Financial Strength System classify public corporations according to characteristics of financial health. Zeta® uses financial variables to discriminate between bankrupt and nonbankrupt firms, whereas Value Line relates similar types of variables to the observed yields of outstanding debt securities. Zeta® is essentially an objective system; Value Line’s ratings are a function of both mathematical relations and human judgment. Both models employ measures of profitability, leverage, size, variability and market value. Zeta®, however, measures earnings variability, whereas Value Line evaluates stock price stability. Value Line’s size measure involves earnings; Zeta® uses total assets.

Despite these differences, a comparison of the two systems reveals that Value Line’s scores exhibit a high correlation with Zeta® scores, which have been shown to discriminate well between bankrupt and nonbankrupt firms. Both systems’ scores also correlate well with published bond ratings.

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