We can determine if a movie is worth our time and money by reading reviews. If a movie earns five stars, it is deemed outstanding, and so on. A score type that recommends whether or not we should invest our time and resources in a specific company is the Piotroski Score. Who said that stock investment is tedious and challenging? But What is Piotroski Score?
Despite challenging market conditions in 2018, the Piotroski Score is the only positive screener performing well. It’s one of the reasons why we significantly weigh the Piotroski Score at Old School Value when we filter and rank the businesses in our universe.
We use it as a tried-and-true technique to weed out speculative companies that haven’t improved or are coming under fire for unfairly manipulating fundamentals. Let’s explore the Piotroski Score and discover all there is to know about it.
What is Piotroski Score?
Joseph D. Piotroski, an American accounting professor at Stanford University’s Graduate School of Business, is widely credited as the inventor of the Piotroski score.
Nine variables contribute to the Piotroski score, such as profitability (4 sub-criteria), leverage, liquidity, sources of funds (3 sub-criteria), and operating efficiency (2 sub-criteria). The companies must meet each of these conditions to receive a point.
The Piotroski score ranges from 0 to 9, reflecting the weight given to each of the nine factors assessing a company’s financial health.
Understanding the Piotroski Score
Piotroski developed a method for comparing each potential holding to nine distinct metrics to identify the businesses that provide the most value. Investors with maximum value returns on capital adopt this strategy because it makes complex financial data analysis straightforward.
By looking at an organization’s income statement, balance sheet, and cash flow statement, the Piotroski score does this. It provides insightful data about its financial performance.
The Piotroski index looks at nine different factors in three other areas. The company must meet each of these conditions to receive a point. A corporation will not receive a bonus or penalty points if it does not meet a criterion. These indicators are:
- Profitability Criteria
- Positive Net Income
- Positive ROA in the current year
- Positive operational cash flow
- Operating cash flow exceeding net income
- Leverage, Liquidity, and Source of Funds Criteria
- Lower long-term debt compared to last year (decreased influence)
- Higher current ratio than the previous year (more liquidity)
- The number of shares issued last year was zero (lack of dilution)
- Operating Efficiency Criteria
- Higher gross margin than last year
- Higher asset turnover than the previous year
A Piotroski score measures financial viability and performance. As a result, companies with a successful track record can get a higher score than those with a more stable track record. A low score may not necessarily indicate a company’s financial stability. However, it does imply that its recent performance has been underwhelming.
Now it should be clear that investors need to determine the Piotroski score of companies over several years to choose stocks that consistently outperform the market.
Evaluating a company’s Piotroski score is a good idea since companies that trade at a low valuation have more space for development. In other words, undervalued yet financially secure Piotroski-scored businesses may be worth considering as investments.
Reading the Score
According to the top 10 stock brokers in India, the Piotroski F-Result, a final result, is produced by adding the points from the nine criteria above.
In 20 years, a firm with an 8 or 9 would gain by 7.5% annually, making it a superb value. Among the businesses in this group are JSW Steel, Vedanta, Ambuja Cements, DLF, and Tata Consumer Products.
The stock is regarded as mediocre and was five times more likely to face financial problems if the score was between 0 and 2 points.
A company with a rating between 3 and 7 is considered average. Some of these businesses may be short-term viable, while others could be dependable businesses with limited room for expansion. These companies are Adani Enterprises, Kotak Mahindra Bank, HDFC, Bajaj Finance, and Reliance Industries.
Advantages of the Piotroski Score
Let’s look at some of the significant benefits of the Piotroski Score to help you comprehend. The advantages are as follows:
- It aids in understanding a company’s financial health, identifying high-value enterprises by investors, and increasing your returns.
- Using this straightforward rating technique, you may discover a company’s advantages. You don’t need any accounting gimmicks, and you can swiftly and thoroughly analyze the stock.
- It assesses current firm performance and compares the current and prior years’ measures
- It makes it easier to spot businesses starting to deteriorate or have a destructive fundamental momentum
- It makes it easier to spot businesses that might be at the start of a trend
- The objectivity of the score makes it evident whether or not a firm complies with particular requirements
- It provides you with a deeper comprehension of the entry and exit points. You may use this as a stop loss (sell if the F-Score is less than 6).
- Since the stock market is volatile, there is no assurance that you will be on the transaction’s winning side even by utilizing various techniques and formulae. But applying this score may boost virtually all of the evaluated techniques’ returns.
These are only a few advantages. However, there are further advantages, such as expanding markets and enterprises. Start using this score and trading for profit at the best stock broker in India.
Limitations of the Piotroski Score
- The Piotroski score only compares an organization’s performance across years. Utilizing this score in cyclical businesses becomes difficult as a result.
- It proves challenging during exceptional circumstances like the Covid-19 epidemic in 2020. Under such circumstances, even a high-quality stock may get a poor rating.
- Looking at previous performance doesn’t guarantee that an investment strategy will continue to provide the same results in the future.
- The Piotroski score is only permissible in a select few businesses. It is unfair to those sectors that heavily depend on debt to finance their operations, such as electronics, energy, transportation, and car manufacturing.
- Companies with high capital requirements that must incur significant debt to maintain efficiency would often do poorly, according to the Piotroski model.
- The use of more ethereal components is forbidden. Think about management effectiveness or a historical review of financial statistics.
The most recent fiscal year’s issuance of new shares is permanently assigned a score of 0. It may be vital to consider this aspect since the model does not consider this root cause.
The Final Word
Piotroski’s April 2000 article “Value Investing ” suggests buying projected winners and shorting usual losers. If used between 1976 and 1996, the Piotroski score approach would have generated a 23% yearly return.
The Piotroski score is an excellent instrument for assessing the financial health of businesses to make investment decisions. However, rather than relying only on this score, which only considers recent data, it is advised that you look at the businesses’ financial histories over several years.
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