Joseph Piotroski, a Chicago Accounting Professor, developed a scale to determine the company’s financial health by analysing some financial aspects. The score attached to stocks using that scale is known as the ‘Piotroski score’.
This article discusses the Piotroski score, how stocks are scored with the Piotroski method and more.
What Is a Piotroski Score
Piotroski score is a metric used to evaluate and screen stocks by assessing their financial strength, thereby finding value stocks, i.e. those stocks that trade at lower prices than their fundamental suggested values.
Understanding Piotroski Score
To use the Piotroski score, one needs to understand the following criteria and sub-criteria.
Profitability
- Net income: Also known as net profit, net income is calculated by subtracting the firm’s total expenses from total income for a year.
- Return on Assets (ROA): ROA shows how much profit a company generates from its total assets. Dividing a company’s net income by its total assets gives ROA.
- Net operating cash flow: The amount of cash a company generates from normal business operations is a net operating cash flow. It can be calculated by adding non-cash expenses like depreciation and subtracting the increase in working capital (capital used for day-to-day operations) from the company’s net income.
- Operating cash flow Vs Net income: As operating cash flow does not consider non-cash items, the net income would usually be higher than the operating cash flow. Though, assessing whether it is so is essential.
Leverage, liquidity, and source of funds
- Leverage: Leverage shows how much assets are funded by long-term debt. It is calculated by dividing the company’s long-term debt by total assets, and lower leverage indicates a lower burden and vice versa.
- Current ratio: Current ratio shows the company’s ability to pay off short-term liabilities using current assets and is calculated by dividing current assets by current liabilities.
- Outstanding shares: If the number of outstanding shares increases, the company’s current shareholders’ ownership percentage may decrease, known as equity dilution. Therefore, it is important to check whether the number of total outstanding shares increased.
Operating efficiency
- Gross margin: Gross margin shows a percentage of total sales that remained as profit after paying direct costs and is calculated by dividing gross profit by total sales.
- Asset turnover ratio: The asset turnover ratio shows how efficiently the company uses its assets to generate revenue and is calculated by dividing total sales by total assets.
How To Score Stocks?
Here is how stocks are given scores according to the Piotroski method.
| Parameters | Score 1 | Score 0 |
| Net Income | Net income > 0 | Net income < 0 (Net loss) |
| ROA | Current year’s ROA > Previous year’s ROA | Current year’s ROA < Previous year’s ROA |
| Net operating cash flow | Operating cash flow > 0 | Operating cash flow < 0 |
| Operating cash flow Vs Net income | Operating cash flow > Net income | Operating cash flow < Net income |
| Leverage or gearing | Current year’s long-term debt < Previous year’s long-term debt | Current year’s long-term debt > Previous year’s long-term debt |
| Current ratio | Current year’s current ratio > Previous year’s current ratio | Current year’s current ratio < Previous year’s current ratio |
| Outstanding shares | No equity dilution as no new shares are issued | New shares are issued, and equity is diluted |
| Gross margin | Current year’s gross margin > Previous year’s gross margin | Current year’s gross margin < Previous year’s gross margin |
| Asset turnover ratio | Current year’s asset turnover ratio > Previous year’s asset turnover ratio | Current year’s asset turnover ratio < Previous year’s asset turnover ratio |
A score between 7-9 indicates good value stocks, and a score of 0-2 suggests that the stock has poor fundamentals.
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Scoring With The Piotroski Method
Let’s understand the Piotroski score with an example. Suppose Keya wants to calculate the Piotroski score of an Indian stock, ABC Limited, for 2020-21. She analysed the following crucial details about ABC Limited. Here is how the stock can be scored according to the Piotroski method for 2020-21.
| Particulars | 2020-21 | 2019-20 |
| Net Income | ₹1,50,000 | ₹1,25,000 |
| ROA | 10% | 8% |
| Net operating cash flow | ₹5,30,000 | ₹5,50,000 |
| Leverage or gearing | ₹5,50,000 | ₹5,00,000 |
| Current ratio | 1.5% | 1.75% |
| Outstanding shares | 5,00,000 | 5,00,000 |
| Gross margin | 25% | 30% |
| Asset turnover ratio | 1.30 | 1.25 |
From the details mentioned above, it is clear that the firm scores 1 each for the following parameters:
- Net income (₹1,50,000>0)
- ROA (10% > 8%)
- Operating cash flow vs net income (₹5,30,000 > ₹1,50,000)
- Outstanding shares (remain the same)
- Asset turnover ratio (1.30 > 1.25)
In contrast, the stock scores 0 each for the following parameters:
- Net operating cash flow (₹5,30,000 < ₹5,50,000)
- Leverage (₹5,50,000 > ₹5,00,000)
- Current ratio (1.5% < 1.75%)
- Gross margin (25%<30%)
Piotroski F-Score Formula
The Piotroski F-score of a stock can be computed by summing up scores of all the nine parameters in all three categories mentioned above.
For instance, the Piotroski F-score of ABC stock is 5. It also means that the firm performed well for profitability criteria (scored 3/4), poorly regarding leverage, liquidity and source of fund criteria (scored 1/3), and moderately regarding operating efficiency criteria (1/2).
Final Thoughts
The Piotroski F-score is one of the indicators used to evaluate a firm’s profitability, liquidity, and operating efficiency, thereby spotting value stocks. However, it uses past data and gives reliable results when no uncertain events happened in the year/years considered for calculating the score.
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FAQs
The Piotroski score helps in spotting value stocks. Though, it may give less effective results if any uncertain event happened in the past year/years under consideration.
Yes, a Piotroski score of eight or nine suggests that the stock stands well in terms of profitability, liquidity, and operating efficiency.
The Piotroski F-score may help more to find value stocks than the price-to-earnings ratio since the former considers nine factors and evaluates a firm’s profitability, liquidity, and operating efficiency.
If no uncertain events happened in the year/years considered for calculating the score, the Piotroski score might act as a good indicator to pick value stocks.
