As investors, when faced with a mountain of information, we tend to succumb to information overload and our brain shuts down. In the Internet age where information and data are ubiquitous, sorting out what’s relevant and what’s not can be time-consuming, tedious and stressful. This is why wise investors have devised their own methods of filtering out unwanted information, and when it comes to screening for suitable investments to consider, there are a number of useful tools one can use to help make the job much easier.
One of the tools is the Piotroski F-Score which is a nine-point scoring system devised by Stanford Accounting Professor Joseph Piotroski in order to look for value stocks. Let’s look at the system more closely and I will also explain how to use it to our advantage.
How The F-Score Works
The F-Score is a simple system where there are nine attributes to be compared, and a score of 1 is given if the attribute is positive and 0 if it is negative. The total score of the attributes is then added together to produce a combined F-Score.
Grouping And Attributes
There are nine criteria broken down into three distinct groups, namely, profitability, leverage and liquidity, as well as operating efficiency. Let’s have a look at each attribute under each heading.
1. Return on assets (ROA) (1 if positive, 0 if negative). ROA = Net profit after tax divided by total assets
2. Operating cash flow (1 if positive in current year, 0 if negative).
3. Change in ROA (1 if ROA in current year is higher than previous year, 0 if not)
4. Accruals (1 if operating cash flow divided by total assets is higher than ROA in current year, 0 if not).
Leverage & Liquidity
5. Change in leverage ratio (1 if the ratio is lower this year compared to last year, 0 if not). Leverage = total debt divided by total equity
6. Change in current ratio (1 if the ratio is higher this year compared to last year, 0 if not). Current ratio = total current assets divided by total current liabilities
7. Change in number of shares (1 if no new shares issued during the last year, 0 if there were).
8. Change in gross margin (1 if the gross margin is higher this year compared to last year, 0 if not)
9. Change in asset turnover ratio (1 if the ratio is higher this year compared to last year, 0 if not). Asset turnover ratio = net sales divided by total assets.
Interpretation And Limitations
Companies which receive scores of 8 or 9 are considered strong and definitely worth a second look, while companies on the other end of the spectrum scoring 0 to 2 are considered weak and the investor should pass.
Note though that this method of screening has its limitations, the key one being that the attributes are all based on financial metrics and ignore other aspects of the company like operations, market share, etc. Companies which have had a good year may also score high but this may be temporary, therefore the investor needs to dig deeper into each company to find out more before deciding on whether to invest.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.