Piotroski F-Score Strategy

Piotroski F-Score is a value investing strategy, which was published by Joseph D Piotroski in 2002. The exact title of the paper is “Value investing: The use of historical financial statement information to separate winners from losers.

For a better understanding of the strategy and its exact economical intuitions, I strongly recommend you to read the paper by following the link - Piotroski F-Score

By introducing this strategy to my readers I only mean that you can use this as a tool to identify some good stocks which are neglected by the market. This article doesn’t give you a strategy to analyze the whole universe of stocks. Researchers found this strategy works really fine and had given an annualized return of 23% from 1976-1996. It is really huge.

 

What is value investing?

Value investing generally pick up stocks which were neglected by the market, after sometime market realizes these are good stocks and then the price goes up.

 

What Piotroski actually did?

Piotroski F-Score strategy giving an algorithm to identify the subset of stocks within the value stocks which is going to outperform the others.

 

Where I can apply Piotroski F-Score?

This strategy applies to the stocks having a high book to market value. The research found that financially strong high BM stocks give an increased return of 7.5% annually than buying all high BM stocks.

 

Algorithm

Piotroski F-Score has three measures each having components, total of nine components.

1.     Profitability measures

2.     Capital structure measures

3.     Operational efficiency measures

Each measure are further divided,

1.     Profitability measures

         i.          Return on Assets (ROA)

·       Net income before extra-ordinary items scaled by the beginning of the year total assets.

·       If the firm's ROA is positive, then indicator variable F_ROA is equal to 1. Zero otherwise.

Note: -  Extraordinary item means, the items which are not included in their primary business (If a pharma company sells their land, it is an extraordinary item. Because their primary products are medicine).

Note: - Beginning of the year’s asset is obtained from the last year’s annual report.

       ii.           Cash flow from operations(CFO)

·       It is defined as the cash flow from operations scaled by beginning year’s total assets.

·       If CFO is positive F_CFO is equal to one otherwise zero.

     iii.          ΔROA

·       It is the current year's ROA less the previous year’s ROA.

ΔROA = Current year’s ROA – Previous years ROA

·       If ROA is positive then, F_ΔROA is 1. Zero otherwise.

     iv.          Accrual

·       It is defined as the current year’s net income before extraordinary items less cash flow from operations, scaled by the beginning of the year total assets.

·       If CFO greater than ROA, i.e. Accrual negative implies F_ACCRUAL equals one. Zero otherwise.

 

2.     Capital structure measures

       v.          ΔLEVER

·       It is the difference in the value of the ratio of total long term debt to average total for the current year and the previous year.

·       ΔLEVER= Current year’s leverage – Previous year’s leverage

·       F_LEVER equals one if ΔLEVER is negative, otherwise zero.

     vi.          ΔLIQUID

·       It is the historical change in the firm’s current ratio between the current year and the prior year. Where the current ratio is the ratio of current assets to current liabilities.

·        F_LIQUID is one if ΔLIQUID is positive, zero otherwise.

   vii.           EQ_OFFER

·       It is an indicator variable whose value is equal to one of the firm did not issue common equity in the year preceding portfolio formation, zero otherwise.

 

3.     Operational efficiency measures

  viii.          ΔMARGIN

·  It is the firm’s current gross margin ratio (gross margin scaled by total sales) less the prior year’s gross margin ratio.

·        F_MARGIN equals one if ΔMARGIN is positive, otherwise zero.

     ix.          ΔTURN

·       It is the firm’s current year’s asset turnover ratio (total sales scaled by beginning of the year’s total assets) less than the prior year’s asset turnover.

·        F_ΔTURN equals one if ΔTURN is positive, zero otherwise.

Composite score

F-Score is the sum of the individual binary signals.

Given the nine underlying signals, F-Score can range from 0 to 9. Where a low F-Score represents a firm with very few good signals and vice versa.

So you can long the stocks having high F-Score.

When to trade?

As early as the financial statements are publically available.

Key point: -  In actual case it is very risky to hold a portfolio having stocks of high book to market value. So I am suggesting you adopt this method to analyze high BM stocks and to find potential multi-baggers from this universe of stocks. For this you have to invest time in this strategy and your skills will give you some potential stocks.

Use Excel to analyze data and also use screeners like tickertape.in, screener.in to find out high BM stocks.

I hope you have understood the above concept if you liked please fill your valuable comments in the comment box and follow my blog to get updated on each content.

Thank you.