According to the Joseph Piotroski’s 2002 paper, high book to market stocks filtered for high Piotroski f-score (buy), and low Piotroski f-scores (short sell) increases the annual returns on average by 7.5% over a market basket of high book to market stocks.
A high book to market portfolio outperforms a broad market index over time. According to this paper, filtering for Piotroski f-score adds incremental and non-significant amount of alpha to the portfolio returns.
We all want that, don’t we?
So, What is the Piotroski F-Score and How do we Use it?
The method proposed by Joseph Piotroski recommends to evaluate the company’s financial statements on 9 different attributes. Either the company passes or fails each of the 9 evaluations. Every pass is awarded 1 point. A fail is awarded no points. All the points are added up to give a final Piotroski f-score between 0 and 9.
Scores of 8 and 9 are considered strong value stocks. Scores of 2 or below are considered weak value stocks.
The 9 criteria is as follows, listed under 3 different groups:
Profitablity
1. Positive Net Income in the current year = 1 point. Company is profitable.
2. Positive Operating Cash Flow in the current year = 1 point. Company is generating cash.
3. Positive change in ROA (Current year vs previous year) = 1 point. Company is improving its profitability.
4. Accruals: Operating Cash Flow > Net Income = 1 point. This is to ensure that the net income is not being driven by a change in accruals.
Leverage, Liquidity and Source of Funds
5. Decrease in Long Term Debt in the current year compared to previous year = 1 point. Leverage is going down.
6. Increase in Current Ratio this year compared to previous year = 1 point. Liquidity is getting better.
7. Current Outstanding Shares <= Previous Year Outstanding Shares = 1 point. There is no share dilution
Operating Efficiency
8. Gross Margin, current year > Gross Margin, previous year = 1 point. Company is getting better at improving profitability
9. Asset Turnover Ratio, current year > Asset turnover ratio, previous year = 1 point. The company is able to generate more revenue from its asset base.
Piotroski F-Score is therefore a quick way to judge a company’s financial strength. Please note that a company with a high Piotroski f-score does not necessarily imply a good value stock. The Piotroski f-score filter needs to be applied in conjunction with other valuation filters. Professor Piotroski himself used this on high book to market stocks (or said differently, low P/B ratio stocks).
It is very possible to find stocks exhibiting high Piotroski f-score and a high valuation. These stocks represent quality, but not value. Therefore, you do need to conduct appropriate fundamental analysis of the stock as you check the f-score.
Screening for Piotroski F-Score
Many professional screeners have filters for Piotrosky f-score built in. For example, I use the Stock Rover screener and it allows me to screen for Piotroski f-score. However, if the screener you use does not offer this filter, you could select the relevant data from the financial statements and create filters in Excel yourself. You will need the following for current year and the previous year
From the Balance Sheet:
- Number of shares outstanding
- Total assets (to calculate asset turnover ratio and ROA)
- Long term debt
- Current Assets and Current Liabilities (to calculate the current ratio)
From the Income Statement:
- Sales
- Net Income
- Gross Margin %
From the Cash Flow Statement:
- Operating Cash Flow
Your goal is to find stocks that are undervalued by your other valuation criteria, and that exhibit a high Piotroski f-score of 8 or 9.
Tip: At Value Stock Guide we publish screens for high Piotroski F-Score.
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