The Piotroski score was named after Joseph D. Piotroski, an American professor of accounting at Stanford University’s Graduate School of Business. The Piotroski score is a measure of the strength of a firm’s financial position used to identify undervalued companies through nine criteria: profitability (4 sub-criteria), leverage liquidity & source of funds (3 sub-criteria), operating efficiency (2 sub-criteria).
Understanding the Piotroski score
Piotroski devised a way to find the best value stock investments by evaluating the financial position of a company against nine criteria. Value investors love the approach because it helps them make sense of sometimes confusing financial reports.
Evaluating the nine criteria of the Piotroski score
The Piotroski evaluates nine criteria spread across three groups. One point is awarded for every criterium that is satisfied. If the company does not satisfy a criterium, no points are added or subtracted.
- Positive net income.
- Positive return on assets greater than the previous year.
- Positive operating cash flow in the current year.
- Cash flow greater than net income.
Leverage, liquidity, and source of funds
- Less long-term debt in the current period when compared to the previous year (decreased leverage).
- Higher current ratio when compared with the previous year.
- No new equity issued in the past year.
- Higher gross margin than the previous year.
- Higher asset turnover than the previous year.
Interpreting the Piotroski score
The points from the nine criteria above are then summed to give a total score known as the Piotroski F-Score.
Companies with a score of 8 or 9 have been found as a group to outperform weak stocks by 7.5% per year over a twenty-year period. Piotroski discovered that weak stocks, with a score of 2 or lower, were five times more likely to experience financial problems.
Companies scoring between 3 and 7 are considered average performance. Some of these companies may also be unsustainable over the long term, while others may be good companies but with little prospect for growth.
It should also be noted that the Piotroski score will not work for every industry, particularly those CapEx-dependent industries where a high level of debt is required to maintain business operations.
- The Piotroski score is a measure of the strength of a firm’s financial position used to identify value stocks.
- The Piotroski score evaluates nine criteria. One point is awarded for every criterium that is satisfied, while zero points are added for every criterium that is not satisfied.
- Companies with a Piotroski Score of 8 or 9 are considered good value investments, with weak or unsustainable companies scoring between 0 and 2. The method itself may be inaccurate in CapEx-heavy industries that require debt to fund operations.
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