the WRDS database, firms have substantially lowered their liquidity over
the 34-year period, with the median current ratio falling from 2.027 in
1970 to 1.703 in 2003. The median debt-to-assets ratio has fallen slightly,
from 0.473 in 1970 to 0.429 in 2003. Sales efficiency has fallen from 1.205
in 1970 to 0.701 in 2003. The median on equity has fallen from 10 percent
in 1963 to 8.2 percent in 2003. The falling liquidity, sales efficiency, and
return on equity have driven the median Altman (new) Z from 2.992 in
1963 to 1.752 in 2003.
We should make one last comparison with JNJ and the 56 firms in the
WRDS database for 2003 in the health care industry. Although JNJ has a
lower current ratio, 1.71, relative to the current ratio of the median health
care sector firm (2.51), its profitability, as measured by its return on equity
and DuPont return on invested capital (0.241 and 0.258), far exceeds the
median health care ROE and DuPont return values of 0.072 and 0.009, re-
spectively, such that the Altman Z score of JNJ (3.04) substantially exceeds
the median health care score of 2.00. JNJ is a highly profitable and lower-
leveraged firm relative to the median firm in its sector or in the economy.
The Altman Z score and its components calculated for the 11 I/B/E/S sec-
tors for 2003 are shown in Table 3.2. There are significant industry effects.
Limitations of Ratio Analysis
Although ratio analysis is an extremely versatile tool, applying it can be dan-
gerous if its limitations are not understood. Ratio analysis may be useless if
the analyst does not have a feeling for the normal differences among differ-
ent industries, or if the analyst does not run his or her analysis for the
appropriate sector or industry. Neither is the analysis likely to be relevant
if the analyst does not allow for special situations that may influence the
38 RATIO ANALYSIS
TABLE 3.2 Median WRDS Firm Altman Z Score and Its Components for I/B/E/S
Sectors in 2003
WRDS Ratios, Median Values, 2003, by I/B/E/S SectorRatio1234567891011
CR 1.665 2.952 2.068 1.671 1.853 1.197 1.291 2.482 1.868 1.941 0.998
SA 0.072 0.681 1.168 1.234 1.273 0.511 1.045 0.812 0.881 1.061 0.438
TDA 0.427 0.323 0.417 0.425 0.470 0.432 0.460 0.323 0.456 0.432 0.475
DuPontA 0.079 0.000 0.080 0.048 0.065 0.051 0.059 0.005 0.037 0.040 0.048
ROE 0.110 0.017 0.120 0.082 0.086 0.085 0.094 0.007 0.068 0.069 0.107
NewZ 1.925 1.844 2.590 2.516 2.514 1.626 2.050 1.827 1.949 2.210 1.109
N 65 603 221 778 149 205 87 937 239 364 250