Piotroski Score: Its Parameter and Interpretation

 

What is Piotroski Score?
Piotroski score is a discrete score that helps investors to identify fundamentally strong companies by analyzing their financial statements. It is a number between 0 to 9 that reflects nine criteria used to determine strength of company’s financial position. It is used to determine the best value stocks, with nine being the best and zero being the worst.

 
Who was Piotroski?
Piotroski, a professor of accounts as part of his understanding the valuation of stocks wanted to understand if fundamental analysis had a role in selecting stocks. He shortlisted stocks with which were in the top 20%. He used their balance sheets and income statements; he used metrics like quality of earnings, leverage, operating cash flow etc. Eventually, he shortlisted 9 parameters under the heads of profitability, leverage, and efficiency, which was called F-score or the Piotroski score.

 
Understanding the Nine Parameters of Piotroski Score?

Profitability criteria includes:

1)Net Income
Net income is often referred as “bottom line” of P&L statement. Net income is obtained by deducting all the expenses from revenue. Net income is the total amount a business earns during a particular period.

What does it measures: If a company has made positive net earning i.e profit during current year.

Score: 1 if net income is positive, else 0.

 
2) Operating Cash Flow
Operating cash flow is the amount of cash a company generates from its business operations. It indicates whether a company can generate sufficient positive cashflow to maintain and grow its operations. It is an important benchmark to determine the financial success of company’s core activities.

What does it measures: If a company can generate positive cashflow to sustain growth.

Score: 1 if operating cashflow is positive, else 0.

 
3) Quality of Earnings
The portion of income a company earns from its core activities rather than investments are called quality of earnings. High quality earnings are a result of good sales and cost optimization. High quality earnings are indicative of a thriving business model with good revenue model.

What does it measure: Whether company’s cashflow from operations is greater than net earnings.

Score: 1 if cashflow from operations is greater than net earnings, else 0.

4)Return of Assets (ROA)
ROA is calculated by dividing company’s net earnings by total assets. It shows whether company’s assets are being employed effectively. Different industry have different ROA percentage. So, ROA should be compared with company’s previous year ratio to give realistic view.

What does it measure: How well company a is managing its asset.

Score: 1 if ROA of current year is greater than previous year, else 0.
 

Leverage criteria includes:

5) Debt to Equity (D/E) ratio
D/E ratio is an important metric which is used to evaluate a company’s financial leverage. It measures company’s debt obligation relative to its shareholder’s fund. Higher ratio indicates higher debt to fund operations. Conversely, very low ratio indicates, assets could be put to better use.

What does it measure: How much assets are financed by debt.

Score: 1 if d/e of current year is less than previous year, else 0.

 
6) Current Ratio
Current ratios indicate the ability of the company to satisfy its current obligations using its current assets. Current ratios of more than 1 indicates that current assets are sufficient to cover current liabilities and current ratio of less than 1 indicates that the company is struggling to pay its debt.

What does it measure: Company’s ability to pay its short-term obligation.

Score: 1 if current ratio of current year is greater than previous year, else 0.

 
7) Outstanding Shares
Shares outstanding refer to a company's stock currently held by all its shareholders, including share blocks held by institutional investors and restricted shares owned by the company’s officers and insiders. Often, companies issue more share to raise capital for expanding its operation by diluting existing shareholder’s stake.

What does it measure: If a is able to grow without diluting its equity

Score: 1 if outstanding share remained the same or lower than previous year, else 0.
 

Operational efficiency criteria includes:

8) Gross Profit Margin
It measures how much sales revenue is left out after deducting cost of goods sold (COGS). High gross profit ratio indicates high efficiency of core operations. On the other hand, low ratio indicates adverse purchasing policies, low selling price, and stiff competition.

What does it measure: Operational efficiency of the company.

Score: 1 if gross profit margin of current year is greater than previous year, else 0.
 

9) Asset Turnover Ratio
It measure the amount of revenue a company generates from every rupee of asset. A high asset turnover ratio indicates higher operational efficiency. Low ratio indicates inefficiency or capital-intensive nature of business.

What does it measure: Company’s efficiency in using its asset.

Score: 1 if asset turnover ratio of current year is greater than previous year, else 0.
 

Interpreting Piotroski score
If a company has a score of 8 or 9, it is considered a fundamentally good stock. Conversely, company with a score between 0-2 is considered weak stock. Companies with a score between 3-7 are in grey area. It indicates that the company is neither weak nor strong.

Following is the list of top 15 companies with Piotroski Score of 9.
 

To get the whole list of companies that have a Piotroski Score of 9 Click Here.

Final Words:
Piotroski score gave an annual return of 23% between 1976 and 1996. It has proved to be a good indicator in the past, but future does not always work based upon past result. So, along with Piotroski score it is necessary to do our own exhaustive research before investing in any company.

Disclaimer: Companies used as an example in this blog are for educational purposes and not an investing advice.

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Happy Investing!