Estimating Firm Book to Market Ratio Using Altman’s Z-Score Ratios: A Study of Firms at the Nairobi Stock Exchange

Abstract

This study looks at the relationship between market to book ratio and risk of firms at the Nairobi Stock Exchange from. January 1996 to December 2003. The proxy for risk is Altman's Z Score ratio formulation. The assumption is that if Altman Z score discriminates between firms of different risk, i.e. bankrupt and non bankrupt firms, the same set of ratios are useful in classifying firms into high and low book to market ratios. This study therefore aims at determining the discriminating ability of Altman's Z score ratios in separating firms with low book to market value ratio from those having high book to market value ratio. I begin by examining the average market returns of each of the stocks at the NSE. I generate coefficients for Altman's variables using group statistics and ultimately Altman's Z score ratio. Using this ratio, I rank the stocks on the basis of book to market value (BMV) ratio by categorizing them into two groups: high book to market ratio firms and low book to market ratio firms. Empirical evidence I obtained suggests that in roughly eight (8) out of ten (10) times, the Z score ratio generated is roughly correct and can be useful in grouping firms into low and high book to market value ratio. This result of this study suggest that Altman's Z ~ore can be useful in making investment decisions in choosing between low and high risk assets. However investors should be warned that Altman's Z score alone cannot be used to make investment decisions. Other factors also playa role, the reason it was not possible to achieve 100% accuracy using Z score to discriminate between firms.