The Piotroski F-Score

by Avrex on August 4, 2013

Valuating a company using the Piotroski F-Score

Congratulations. You’ve discovered a nice cheap value stock to invest in.
But wait. Maybe that company’s stock price is cheap and/or unpopular for a reason.
Maybe the company’s financial health is not as good as you think and that’s the reason the stock price has been beaten down.

Back in 2000, professor Joseph Piotroski wrote an important paper, on a method of fundamental analysis that he derived, entitled, Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers.

Piotroski looked at nine fundamental signals to measure the health of a company.
He gathered this data by looking at the company’s last two annual financial statements.

For each checklist item below, a company would score 1 point for a pass and a 0 points for a fail.

  1. Net Income. Is the last year net income positive.
  2. Operating Cash Flow. Is the last year operating cash flow positive.
  3. Return on Assets. Is last year’s ROA greater than the prior-year ROA.
  4. Quality of Earnings. Does the last year of operating cash flow exceed net income.
    (This warns of possible accounting tricks)
  5. LT Debt vs Assets. Is the ratio of long-term debt to assets down from a year-ago.
    (i.e. Is debt decreasing?). If a company has no long term debt, they still score 1 point, as long as the assets are increasing.
  6. Current Ratio. Is the last year current ratio greater than the prior-year current ratio.
    (i.e. This measures increasing working capital.)
  7. Shares Outstanding. Is the number of shares outstanding no greater than a year-ago.
    (i.e. Share buy-backs are better than share dilution.)
  8. Gross Margin. Is the last year gross margin greater than the prior-year gross margin.
    (i.e. This could indicate improving competitiveness.)
  9. Asset Turnover. Is the last year asset turnover ratio (percentage in increased sales) greater than the prior-year asset turnover ratio. (i.e This could indicated increased productivity.)

Adding up these scores gives the company a resulting ‘Piotroski F-Score’. A perfect score is a 9.
Piotroski back-tested his method and showed that it would have produced returns well above the broader market averages over a two-decade period.

Research your company

As you can see, with a couple of years of financial data, it’s relatively easy to come up with an F-Score for a company that you want to research.

One thing to keep in mind is that the Piotroski F-Score is just one valuation method. A single method should not be used in isolation. There are dozens of valuation metrics that are utilized at Avrex Money, when evaluating a stock.

However, having said that, the Piotroski F-Score metric is a good method to use as a start, with it’s combination of nine fundamental signals.

“But, I don’t want to have to do all that research work.
Give me some F-Scores of companies that I want to invest in.”

I’m glad you asked. 🙂
In a couple of weeks, I’ll post the F-Scores of companies that are potential investment candidates. To ensure that you don’t miss out, don’t forget to sign up for my free email updates.

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{ 2 comments… read them below or add one }

S. B. September 8, 2013 at 1:56 PM

It’s an interesting approach, but I would note that none of the “points” involve any consideration of the current share price. Thus, I would think you’d want to combine this with some valuation metrics. Otherwise, in isolation the approach would have you buy solid companies, but at any price.

Reply

Avrex September 8, 2013 at 10:51 PM

The Piotroski F-Score is only one set metrics that can be used.
I regularly look at a couple dozen financial metrics before I invest in a company.
I completely agree with you. The Piotroski F-Score should not be used in isolation, but it is still a useful financial health indicator.

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