Quantitative Basics – Piotroski F score

The Piotroski F score is a quantitative checklist for quickly spotting possible value stocks. It uses 9 different metrics to score each stock between 0-9 with 0 being a poor value stock and 9 a strong value stock. The value of each metric is binary. A stock scores 1 if it meets the criteria and 0 if it doesn’t. The sum of all the scores will have a maximum value of 9.

The metrics and criteria that register a 1 are as follows:

  1. Positive net income in the current year
  2. Positive operating cash flow
  3. Higher return in assets in current year compared to previous year
  4. Operating cash flow exceeds net income (excluding extraordinary items)
  5. Decrease in long-term debt in current year compared to previous year
  6. Higher current ratio this year compared to previous year
  7. No new shares issued in the current year
  8. Higher gross margin in current year compared to previous year
  9. Higher asset turnover in current year compared to previous year

This is a good checklist to quickly gauge the attractiveness of a stock. It does however come with its limitations. For example, the F score only looks at 2-year results at most. Points 3,5,6,8 and 9 all require an increase for a particular metric over a 2-year period. This can be quite short sighted and can lead to a cyclical stock having a large score simply because the underlying commodity it relies on has gone up in price. The oil and gas majors and mining companies fall into this category.

The second limitation is that some of the metrics create more noise than signal. For example, a company issuing new shares and diluting shareholders is not necessarily a bad thing. A company issuing shares when its stock is expensive can be an efficient way of raising cheap capital. This is what Henry Singleton did with Teledyne stock when it was trading at expensive multiples. However, using the F score, the logic behind the share issue is not factored in.

The F score is a good initial checklist for analysing stocks. While I don’t personally use it, I see utility in having checklists because they improve decision making and reduce bias. An improved version of the F score would be to simply increase the time horizon from the current maximum of 2 years to the length of a full business cycle – say 7-10 years.

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