What is the Piotroski F-Score?
The Piotroski F-Score is a point scale from 0 to 9 that reflects the nine criteria used to determine the financial strength of a company. The Piotroski F-Score is used to identify the stocks or companies with the best value, where 9 stands for the companies with the best profitability, financing and efficiency. 0, on the other hand, means a company’s profitability, financing and efficiency are extremely poor according to the Piotroski F-Score.
The Piotroski F-Score is named after the Stanford professor of accounting Joseph Piotroski, who also developed the scale. To determine the scale, the company’s accounting results for the last few periods (years) are analyzed. One point is awarded for each fulfilled requirement of the selected financial ratios and then added together to determine the most profitable companies.
The components of the Piotroski F-Score
The Piotroski F-Score focuses on the following three parts: Profitability, Financing and Efficiency. If the criteria are met, the company is awarded one point. If the criterion is not met, no points are added. However, no points are deducted.
Profitability
The Piotroski F-Score uses four criteria or financial ratios for profitability:
- Positive net income
- Positive return on assets (ROA) in the current year
- Positive operating cash flow in the current year
- Cash flow from operating activities is greater than net income
Debt, liquidity and source of funds
The financial indicators for debt, liquidity and source of funds in the Piotroski F-Score are as follows:
- Lower debt: Lower long-term debt in the current period compared to the previous year (change in leverage)
- More liquidity: Higher current ratio / working capital this year compared to the previous year – change in 3rd degree liquidity
- No dilution: no new shares were issued last year
Operating efficiency
The key financial figures for operating efficiency include:
- A higher gross margin compared to the previous year
- A higher asset turnover rate compared to the previous year
How is the Piotroski F-Score interpreted?
If a company achieves a score of 8 or 9, it is a good company, while a company with a score of 0 to 2 is described as currently weak or at risk of insolvency. In his research, Piotroski published in 2000, Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers, that the Piotroski F-Score method would have produced an annual return of 23% between 1976 and 1996 if the expected winners had been bought and the expected losers sold. If only the winners had been bought according to the Piotroski F-Score, this would still have resulted in a considerable excess return of 13.4 % compared to the market.
Application of the Piotroski F-Score
Apart from the fact that the Piotroski F-Score can be used to compare companies in the same industry, the Piotroski F-Score can also help to search for specific companies with a high score. There are now several platforms that display the Piotroski F-Score, so you can filter by the highest Piotroski F-Score. This may make it possible to discover companies that were not previously of interest to the investor.
The Piotroski F-Score can also be used to check your own portfolio. The score is used for a brief analysis. The analysis can reveal possible negative developments. When investing, it is worth reviewing the portfolio regularly and disposing of companies that no longer meet the requirements – it may be worth hiring a professional who can interpret the figures correctly.
Disadvantages of the Piotroski F-Score
Of course, as with any investment system, looking at past results does not mean that it will work as well in the future.
The Piotroski F-Score is not suitable for every share or every company. For example, start-ups may find it difficult to meet the defined criteria. The Piotroski F-Score is therefore only applicable and meaningful for established companies.
The Piotroski score can only assess the quality of the company. However, the F-Score does not indicate whether the current share price is in line with the quality. To find this out, a company valuation must be carried out. In addition, the Piotroski F-Score can fluctuate greatly. Therefore, the score should never be used as the only analysis tool. The analysis of shares should be carried out using several indicators and can be very complex under certain circumstances. It is therefore worth commissioning a good asset manager to manage your securities portfolio. They will not only analyze the quality of the company, but also the valuation compared to the actual intrinsic value of the company.