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Trading Coal Stocks: Between Bankruptcy Risk and a Bottom

NEW YORK ( TheStreet) -- The situation continues to look pretty bad for coal stocks, as it has since last year.

Low natural gas pricing and weak demand in a warm winter has kept a lid on coal. The steel market growth profile in 2012 and need for metallurgical coal is OK at best. These companies are in a difficult balance sheet situation, but they've been here and done this cash crunch dance before. Smart investors often say to buy when there is fear in the market, and coal stocks have come back a little from October lows.

Is the next move closer to bankruptcy or an extended bounce?

It can't get much worse for coal stocks, or can it?

First, the grim bankruptcy red flag facts.

Coal stocks are at significant balance sheet risk based on the Altman Z bankruptcy risk ratio, which was invented by New York University professor Edward Altman in 1968. The Altman Z-Score measures several aspects of a company's financial health -- including working capital, total assets, total liabilities, market capitalization, sales, retained earnings and earnings before interest & taxes (EBIT) -- to forecast the probability of a bankruptcy protection filing within two years. Since its inception, the formula has been 72% accurate in predicting corporate bankruptcies two years prior to the filing, according to Investopedia.

Companies with a Z-Score of 3 or higher are considered safe with little danger of bankruptcy, while those with a score of 1.81 or lower are considered distressed and are more likely to go bankrupt. Anything in between is a grey area.

Continue reading to see which coal stocks that look risky based on this bankruptcy metric ...

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