The Piotroski score is a discrete score between zero and nine that reflects nine criteria used to determine the strength of a firm’s financial position. Ranging from zero (weak) to nine (strong), the Piotroski score is a valuable tool used by investors to pinpoint the best value stocks.
Conceived by Chicago Accounting Professor Joseph Piotroski, this scoring system is based on specific aspects of a company’s financial statements, particularly focusing on recent accounting results. For each criterion met, one point is awarded; these points are then tallied to provide an overall score indicating the stock’s value potential.
Why Use the Piotroski Score
- Accurate Valuation: The Piotroski score incorporates nine key factors reflecting a firm’s financial strength, offering a well-rounded analysis.
- Proven Origins: Named after its inventor, Professor Joseph Piotroski, the score is backed by rigorous academic research based on historical financial data.
- Comprehensive Evaluation: By assessing core financial aspects over a number of years, it outlines a clear and concise financial profile of the company.
- Objective Metrics: By providing scores for each criterion met, it levels the playing field for evaluating different companies.
- Value Determination: Stocks scoring high (8-9) are usually great values, while those scoring low (0-2) are likely poor investments.
Breaking Down the Piotroski Score
The Piotroski score evaluates a company based on three broad categories:
Profitability Criteria Include:
- Positive net income (1 point)
- Positive Return on Assets (ROA) in the current year (1 point)
- Positive operating cash flow in the current year (1 point)
- Cash flow from operations greater than net income (quality of earnings) (1 point)
Leverage, Liquidity, and Source of Funds Criteria Include:
- Lower long-term debt in the current period compared to the previous year (decreased leverage) (1 point)
- Higher current ratio this year compared to the previous year (more liquidity) (1 point)
- No new shares issued in the last year (lack of dilution) (1 point)
Operating Efficiency Criteria Include:
- Higher gross margin compared to the previous year (1 point)
- Higher asset turnover ratio compared to the previous year (1 point)
Interpreting the Piotroski Score
If a company scores between 8-9 points, it is regarded as a strong value investment. Conversely, if a company scores 0-2 points, the stock is deemed weak. Piotroski’s April 2000 paper “Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers,” demonstrated that robust stock selection based on this scoring method yielded a 23% annual return between 1976 and 1996.
However, potential investors must remember that past performance is not indicative of future outcomes. Therefore, combining this metric with comprehensive research is a prudent strategy for success in the financial markets.
Practical Example: Application of the Piotroski Score
To see the Piotroski scoring method in action, let’s analyze Foot Locker, Inc. (FL) for fiscal year 2020.
Profitability Calculation:
- Net income: $323,000,000 (Score: 1 point)
- ROA: 4.7% (Score: 1 point)
- Net operating cash flow: $696,000,000 (Score: 1 point)
- Cash flow from operations: $696,000,000 (> net income $323,000,000) (Score: 1 point)
Leverage Calculation:
- Long-term debt: $110,000,000 versus prior year’s $120,000,000 (Score: 1 point)
- Current ratio: 1.7 versus prior year’s 2.0 (Score: 0 points)
- No new shares issued in 2020 (Score: 1 point)
Efficiency Calculation:
- Gross margin: 28.9% versus prior year’s 31.8% (Score: 0 points)
- Asset turnover ratio: 1.11 versus prior year’s 1.54 (Score: 0 points)
In 2020, Foot Locker’s total Piotroski score was 6 out of 9, suggesting it could be an average value proposition heading into 2022 according to the Piotroski method.
Related Terms: Value Stocks, Financial Statements, Return on Assets, Operating Cash Flow, Current Ratio, Gross Margin, Asset Turnover Ratio, Price-to-Book Value.
References
- Joseph D. Piotroski. Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers. Journal of Accounting Research, Vol. 38, Supplement: Studies on Accounting Information and the Economics of the Firm, 2000, Pages 1-41.
- Foot Locker. “2020 Annual Report”.
