The Piotroski F-Score

This blog post will discuss the Piotroski F-Score. What it is. Why it matters. And how to use it in Stock Rover.

What is the Piotroski F-Score?

Joseph Piotroski is a professor of accounting at Stanford University. He published a paper in 2000 that detailed a method for deciding whether or not a stock had solid financials, and if the financials were getting better. His system uses nine criteria targeting three areas: profitability, capital structure/financial liquidity, and operating efficiency. For each criterion that a stock passed, it would get one point. So at the end the stock would have between zero and nine points, which would be its “F-Score.” A stock that had an F-score of eight or nine is considered to be financially very sound, whereas a stock achieving a score of zero, one or two is considered to be financially weak.

One thing to note is the average value of the Piotroski F-Score can differ in different sectors. For example in the S&P 500, the Health Care sector currently has an average F-Score of 6.1 whereas the Communication Services sector currently has an average F-Score of 4.9. So the fact that different sectors and industries can have different group averages needs to be taken into consideration when comparing the F-Scores of companies across sectors. The following table shows the average Piotroski F-Scores for each sector using the S&P 500 as the source population of stocks.

Sector	Size	Average F-Score
Basic Materials	22 Stocks	5.8
Communication Services	8 Stocks	4.9
Consumer Cyclical	79 Stocks	5.6
Consumer Defensive	37 Stocks	5.5
Energy	29 Stocks	5.9
Financial Services	72 Stocks	5.3
Healthcare	61 Stocks	6.1
Industrials	72 Stocks	5.8
Real Estate	31 Stocks	5.5
Technology	65 Stocks	5.8

Initially Piotroski developed the F-Score to apply to value stocks, in order to separate the value stocks with poor financials from those with strong ones. However the F-Score can be applied usefully to all different types of stocks.

The Piotroski F-Score Criteria

Profitability

1. Return on Assets > 0

Return on Assets (ROA) is calculated by dividing Net Income by Total Assets, so this in effect measures if the company had positive net income (or profits). It’s a straightforward test: financially sound companies should be profitable.

2. Cash Flow > 0

Cash flow is another (and many believe better) way to gauge earnings, and measures how much money is going in or out of the business. A positive cash flow ensures that the company is generating enough cash from day-to-day operations in order to continue its day-to-day operations. A firm can have a positive net income but negative cash flow, which is why this criterion is included in addition to ROA > 0. Additionally, cash flow is harder to manipulate under GAAP than Net Income is.

3. Return on Assets > Last Year’s Return on Assets

This equation measures whether or not the firm is improving its profitability. If the company was less profitable this year than last, it could signal that there are financial troubles to come.

4. Cash Flow > Income After Tax

This equation also measures profitability and is meant to weed out any stocks that may be playing accounting tricks in order make their earnings appear larger than they are. Because income has had taxes and depreciation subtracted from it, cash flow is generally larger than income. If it’s not, then it means that the firm may be shifting earnings forward, thus misrepresenting them in the long run.

Capital Structure

5. Long Term Debt/ Total Assets [now] < Long Term Debt/ Total Assets [1 year ago]

This ratio targets capital structure: Piotroski was looking for stocks that were decreasing their debt, increasing their assets, or both. In other words, cases where the ratio of long term debt to total assets would be decreasing. Taking on more debt, while not an inherently bad sign, increases its financial risk and may signal that the company is not generating adequate cash flow.

6. Current Ratio [now] > Current Ratio [1 year ago]

The Current Ratio is the Current Assets divided by Current Liabilities, and is used to gauge the liquidity of the firm. If a company is liquid, then it can easily pay its debts. The higher the ratio, the more liquid the firm. Though if it’s too high, that can signal other issues, like an inefficient use of capital. Like every accounting ratio, this one does not tell the whole story, but by requiring an improving current ratio, this criterion ensures that passing companies will have an increased ability to meet their financial obligations.

Pause: what’s the difference between #5 and #6?

At this point you may be saying, #5 and #6 deal with assets and liabilities, so why are they both needed? Essentially, they deal with different timelines of financial security. Criterion #5 (Long Term Debt/Total Assets) looks at a longer time line, and thus deals with solvency, whereas criterion #6 (Current Assets/Current Liabilities) uses a shorter timeline, and thus deals with liquidity. A solvent firm has a positive net worth, whereas a liquid firm is able to pay all of its current bills, and both are important for financial health.

A company can be solvent (total assets greater than long-term debt) but still have a liquidity problem, meaning it doesn’t have enough cash (or easily sellable assets) on hand in order to pay its bills. However, because a solvent company has a more manageable debt load, it’s better able to borrow against its assets to raise cash in the short term. On the flipside, a company can be insolvent (long term debt greater than assets), but still have enough cash or liquid assets on hand to meet all its short-term obligations. While this company would be able to carry on with business as usual, it could be headed for financial distress further down the road. Piotroski was looking for companies that had a low degree of financial risk in both the short and long runs, which is why both criteria in #5 and #6 are included.

7. Shares [now] <= Shares [1 year ago]

This criterion also targets the capital structure by only letting in companies that have not issued any common stock in the past year. In addition to reducing the value of an investment, share dilution can signal that the company can’t cover its current liabilities, which is another sign of financial distress.

Efficiency

8. Gross Margin [now] > Gross Margin [1 year ago]

Gross Margin (or Gross Profit Margin) is the percentage of revenue that’s left over after paying the costs of producing the goods sold. By weeding out companies that weren’t able to increase their gross margins in the past year, this criterion selects for companies that are becoming more efficient and thus are expected to be more profitable.

9. Sales/Total Assets [now] > Sales/Total Assets [1 year ago]

The final criterion in Piotroski’s score screens for an increase in Sales/Total assets, also known as asset turnover. An increasing asset turnover ratio signals that the company is able to generate more sales with their assets, and thus is also a measure of efficiency.

Pause: what’s the difference between #8 and #9?

Screening for an increasing gross margin ensures that the company is able to keep its costs under control, whereas screening for increasing asset turnover ensures that the company is able to grow its sales relative to its assets.

The Piotroski F-Score in Stock Rover

So where does the Piotroski F-Score show up in Stock Rover?

The Insight Panel

The answer is in multiple places. Let’s start with the Insight Panel, specifically the Insight Panel’s summary tab. You can get to this display by selecting “Insight” from the gray selector tab on the left side of the Stock Rover window. Below you can see a screenshot of a section of the Insight Panel summary tab for McDonald’s (MCD) with the Piotroski-F-Score highlighted. The current score for McDonald’s is 6, which is slightly above average for its sector, Consumer Cyclicals, which as an average of 5.6. One cool thing about the Insight Panel, is you can see how the F-Score has evolved over time. For McDonald’s the score was 5 for a few years, then 7 for a couple of years and 6 the last few years. Mousing over any bar will give the score and the year for that bar.

Note that for the above Scores display, which includes the Piotroski-F-Score, Premium Plus users can see an unlimited number of tickers. Premium users can see 20 distinct tickers a month and Essential users can see 10.

The Table

The Piotroski F-Score is a Premium Plus metric in Stock Rover. You can add the Piotroski F-Score to any view in the table you like. By default, Stock Rover ships with the F-Score in both the Financial Health view and the Scores view. A snapshot of the Financial Health view is shown below for the Dow 30 stocks.

Three Screeners

First I must mention the usual caveat about screeners. The population of stocks that pass any screener are just a starting point, providing an interesting set of candidates for more more in-depth research. Capital should never be committed to a stock on the basis of passing a screener alone.

Turning back to Piotroski, one of the best things about the Piotroski screeners is rather than screening for stocks against a hard value (Gross Margin > 10%, for example), most of the screener’s criteria compare metrics against their values from a year prior. This is advantageous because many metrics have wildly different values depending on the industry or sector of the company. By using criteria based on relative values, Piotroski screeners are able to pull from all corners of the market.

Stock Rover provides three Piotroski F-Score screeners. There is one included with your account by default called the “Piotroski High F-Score”. It screens from over 12,000 stocks which Stock Rover covers from the NYSE, NASDAQ, Toronto and TSX Venture exchanges, across all sectors and industries and all market cap sizes. The screener returns all the companies that have a perfect F-Score of 9. For the purposes of this blog, I modified the screener to screen from just the major U.S. listings, which encompasses around 3,400 of the largest stocks trading on U.S exchanges. See the screenshot below to see the criteria used for the Piotroski High F-Score screener in this blog post.

This is what the screener returned on August 6th, 2019.

In addition to the Piotroski High F-Score screener there are two other Piotroski screeners in the Stock Rover Library available that are variants of this screener. The first is the “Piotroski F9 – Mid and Large Cap” screener. This screener looks for companies that have a perfect F-Score of 9 and a market cap greater than 2 billion dollars and trade on the NYSE or NASDAQ exchanges. As of August 6th, 2019, the following 18 stocks passed the screener as shown below.

The final Piotroski screener variant is the “Piotroski High F-Score – Large Cap”. This screener looks for companies that have a score of 8 or 9 and a market cap greater than 10 billion dollars and trade on the NYSE, NASDAQ or Toronto exchanges. As of August 6th, 2019, 61 stocks passed this screener. Below is a screenshot of most of the passing stocks.

Summary

The key thing about the Piotroski F-Score and the associated screeners is that they generate a population of companies that are very strong financially. Whether this translates to success in the market as far as price appreciation goes, is very much dependent on the state and the psychology of the market.

For example if the market is in growth mode, which as of this writing, it has been for quite some time, then investors are much more tolerant of companies that have weaker financials. This means that stocks with high Piotroski F-Scores may underperform the market, as well as underperform companies with weaker financials, because risk is on.

However when things go south and panic hits, it is safe to say that stocks that score well with the Piotroski criteria will generally offer much better capital protection. Portfolios containing high F-Score stocks would be expected to suffer smaller maximum drawdowns in uncertain financial times. The challenge for the investor is understanding the times we live in. And even more challenging for the investor is being able to accurately project the times we will soon be living in and then constructing a portfolio that fares better in such times.