Another great article. Piotroski Score – in line with Warren Buffett’s value investing tenants.
University of Chicago Accounting Professor, Joseph Piotroski reasoned that because value stocks are by definition often troubled companies, many will not possess the financial resources to recover. Consequently, Piotroski wondered if it was possible to improve the performance of a value stock portfolio by eliminating stocks that were the weakest financially.
Piotroski devised a simple nine-criteria stock-scoring system for evaluating a stock’s financial strength that could be determined using data solely from financial statements.
One point was awarded for each test that a stock passed. Piotroski classed any stocks that scored eight or nine points as being the strongest stocks. His findings were that these strong stocks as a group outperformed a portfolio of all value stocks by 7.5% annually over a 20-year test period. Piotroski also found that weak stocks, scoring two points or fewer, were five times more likely to either go bankrupt or delist due to financial problems.
First published in 2000, Piotroski’s scoring system has been found by a variety of researchers to throw up stocks that regularly outperform the market. Here’s how it’s calculated:
Score one point if a stock passes each test and zero if it doesn’t. The maximum score is 9.
- Net Income: Bottom line. Score 1 if last year net income is positive.
- Operating Cash Flow: A better earnings gauge. Score 1 if last year cash flow is positive.
- Return On Assets: Measures Profitability. Score 1 if last year ROA exceeds prior-year ROA.
- Quality of Earnings: Warns of Accounting Tricks. Score 1 if last year operating cash flow exceeds net income.
- Long-Term Debt vs. Assets: Is Debt decreasing? Score 1 if the ratio of long-term debt to assets is down from the year-ago value. (If LTD is zero but assets are increasing, score 1 anyway.)
- Current Ratio: Measures increasing working capital. Score 1 if CR has increased from the prior year.
- Shares Outstanding: A Measure of potential dilution. Score 1 if the number of shares outstanding is no greater than the year-ago figure.
- Gross Margin: A measure of improving competitive position. Score 1 if full-year GM exceeds the prior-year GM.
- Asset Turnover: Measures productivity. Score 1 if the percentage increase in sales exceeds the percentage increase in total assets.
It’s always good to come up with a score-sheet/checklist when analysing a company and before investing in it. A checklist ensures that our thoughts are not skewed and that we are disciplined.