The Piotroski F Score is a back-tested strategy that can help you find the best value stocks with the most significant potential gains and, due to its simplicity, you can use it with ease.
Tim Fries, co-founder of tokenist.com, goes on to say in reformatted, highlighted, edited and abridged excerpts from his original article:
What is The Piotroski F Score?
The Piotroski F Score is a financial rating system for stocks based on fundamental analysis, and it calculates a comparative score of a company’s inherent value….to help you find the best crème de la crème value stocks with the most significant potential gains. In fact, by back-testing it against stock market the Piotroski F Score has shown that John Piotroski’s system would have beaten the average return on the stock market by 13.4% during the period from 1976 to 1996.
Piotroski points out that “the success of the strategy is based on the ability to predict future firm performance and the market’s inability to recognize these predictable patterns“. When we can identify the correct financial signals in a stock, we can invest before the market reacts to our picks (the market is insensitive to the signs until the company’s actual future earnings are announced) and take advantage of the information lag and get higher returns, effectively beat the market.
While the Piotroski F Score is a system that can be used to screen value stocks for these financial signals, though, it is not a magical formula. The author notes that alternate systems using the same broad concepts can be created and offer similar benefits.
What Does the Piotroski Scale Tell You?
The Piotroski scale gives us a rating for how strong the financial fundamentals are for a value stock. There are 9 conditions one should look for in a value stock, and for each condition that’s fulfilled, one point to the stock’s total score. Since the Piotroski F Score for a company can be between 0 and 9 so, naturally, companies at the bottom of the scale (0-3) can be considered companies with weak fundamentals. On the other hand, companies at the top of the scale (8-9) have powerful fundamentals and are most likely to keep performing well in the future.
How Is the Piotroski F Score Calculated?
The Piotroski F Score is calculated based on data obtained from a stock’s financial statements and is available on many financial sites.
To understand how the process works and, more importantly, the nine binary parameters it uses please refer to the original article if you are so interested in such detail. Suffice it to say that the nine conditions used in calculating the score are divided into three functional groups: profitability, leverage, liquidity, and source of funds and operating efficiency. For a practical example of how all the parts of the system work together and how how to use it to find the best of the best when it comes to value stocks, once again, please go here.
How to Invest Using the Piotroski F Score
In an ideal world, we should pick stocks based on their Piotroski F Score, however, like all financial models and metrics, context is vital. One of the significant pitfalls retail investors should avoid while using the Piotroski F Score is ignoring the general industry trends.
How Accurate is the Piotroski Scale?
From a technical point of view, the Piotroski F Score is 100% accurate. It is essentially taking figures from companies’ financial statements and checking for a few particular things. A more pressing question is the following—how good is it at predicting the future?
It’s important to note that due to unforeseen events like an economic downturn, a recession, or even a once-in-a-lifetime global pandemic, the markets can plummet regardless of what anyone’s fancy models or indicators predict yet, ignoring any extreme situations, there is likely quite a lot of merit to the Piotroski F Score.
Overall, the Piotroski F Score is just another indicator that you can use for stock analysis. It is handy for differentiating between value stocks in the same industry, but over-reliance on it (or any single metric), especially in today’s hyper-charged markets, shouldn’t be practiced.
Since the Piotroski F Score is based on general accounting and financial reporting principles, it allows us to quickly glance at the companies’ financial performance and stability which is essential for value stocks to keep growing and, as such, offers a comprehensive approach towards selecting fundamentally strong value stocks.