The Piotroski F-Score is a simple, 9-point scoring system that rates companies based on basic accounting information.
It was originally described in a white paper by Stanford accounting professor Joseph Piotroski as the result of an examination of "whether a simple accounting-based fundamental analysis strategy, when applied to a broad portfolio of high book-to-market firms, can shift the distribution of returns earned by an investor."
He identified 9 factors that led to a 7.5% outperformance in his backtesting period, and 23% average annual returns when used in a long/short portfolio. We have also recently backtested the Piotroski F-Score and have continued to observe outperformance.
As Piotroski limited his universe to high book-to-market firms (or low price-to-book ones), his strategy is particularly effective for these types of stocks.
PROFITABILITY SIGNALS
- Positive net income compared to last year (1 point)
- Positive operating cash flow in the current year (1 point)
- Higher return on assets (ROA) in the current period compared to the ROA in the previous year (1 point)
- Cash flow from operations greater than ROA (1 point)
LEVERAGE, LIQUIDITY & SOURCE OF FUNDS
- Lower ratio of long term debt in the current period compared to the value in the previous year (1 point)
- Higher current ratio this year compared to the previous year (1 point)No new shares were issued in the last year (1 point)
OPERATING EFFICIENCY
- A higher gross margin compared to the previous year (1 point)
- A higher asset turnover ratio compared to the previous year (1 point)
The higher the score the better. The score ranges can be interpreted as follows: 1-4 is a bad score. 5-6 is acceptable. 7-9 is great. The Piotroski score will not work for every industry like financials or Capital Expenditure-heavy industries where debt is required to keep the business operating. Remember, the focus of the research was on high book-to-market firms (low P/B), so performance of this model improves when combined with such firms.
