Piotroski Score – Quantitative Investment Technique
Piotroski Score is a score used by long-term investors to shortlist the best stocks to invest in. It is defined by a number between 0 to 9 (9 being the best) which helps in assessing a company’s financial strength.
Joseph Piotroski, an American Professor after which the score is named, did a lot of research on Value Investing. He examined whether a simple accounting-based fundamental analysis stock selection strategy could impact returns for investors. He ran a lot of tests on the financial statements of companies which had a high book/market ratio (where book value of the company is higher than its market value). These tests included metrics such as the current ratio, asset turnover ratio, change in gross margin etc.
From there, he developed the Piotroski Score which is based on 9 different criteria, which are further divided into three groups. If the Stock has a Score of 8 or 9, then the stock is considered to be a good potential investment. A Piotroski Score of 0 to 2 gives a picture of the poor financial position of a company, and indicates that an investment in such a company can cause losses.
How to calculate the Piotroski Score?
The score is calculated by giving 1 point to the company for every criteria met by it, and no points are awarded if the criteria is not met. Further, the points are summed up to calculate the final score. The 9 criteria are given below :-
- Return on Assets – if positive in the current year : 1 point.
- Operating Cash Flow – if positive in the current year : 1 point.
- Return on Assets – of current year is higher than the return on assets of previous year : 1 point.
- Operating Cash Flow – if exceeds the net income : 1 point.
Leverage, Liquidity and Source of Funds :-
- Long-term Debt vs. Assets – if long-term debt to assets ratio is reduced (by reduction in debt or increase in assets) from previous year’s ratio : 1 point.
- Current Ratio – if increased from that of previous year : 1 point.
- New Shares – if not issued in the current year : 1 point.
Operating Efficiency :-
- Gross Margin – if exceeds the previous year’s gross margin : 1 point.
- Asset Turnover Ratio – if exceeds the previous year’s ratio (i.e. percent increase in sales is higher than percent increase in assets) : 1 point.
Piotroski also found that buying the top stocks and selling short the top losers in the market according to his score would have resulted in 23% annualised returns from 1976 to 1996. Investment portfolio of stocks shortlisted using this score has a high chance of out performing the market.
Piotroski’s complete research paper link – Value Investing : The Use of Historical Financial Statement Information to Separate Winners from Losers
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