Understanding the Piotroski F-Score

One of the most important metrics according to me while fundamentally analyzing any company is it’s Piotroski score, the Piotroski score can be understood as a value between zero and nine that helps investors and other stakeholders understand a firm’s financial strength. This score is mostly used to determine the best value stock , with nine representing a financially strong company while zero representing a financially weak and vulnerable company.

The Piotroski score considers three broad variables to ascertain financial strength :

1. Profitability - This further includes factors like net profit, return on assets (ROA), operating cash flow in the current financial year. If all of these factors remain in positive territory then the company is usually awarded 1 point for each of these factors. Also the operating cash flow should be greater than the net profit/income of the company.

2. Leverage used, Liquidity and Source of funds - Under leverage, this concept includes long term debt of the company i.e - if the company has decreased leverage in the current financial year compared to the previous year, then 1 point is given for the same. Liquidity is judged by the current ratio of the company i.e the company must have a higher current ratio in the current financial year. Lastly, the company must not have diluted equity in the last financial year. These two factors also provide the company a point each.

3. Operating Efficiency - For ascertaining the operating efficiency, gross margins and asset turnover ratios are compared with that of the previous financial year, both must be greater relative to last year, this provides the company with 1 point each.

Reading the score - If a company has a score of 8-9, it is considered as a company with good financials, 0-3 usually stands for weak financials while anything between the two is read as a company with average financial strength.

I personally use this score to get a? broad sense of the financials of any company, since looking at each metric individually is quite time consuming. However, it must be kept in mind that like other metrics, standalone Piotroski score does not suffice while making an investment decision since other qualitative factors also have a say in the success of any company. Also the use of Piotroski score does not guarantee a stock’s performance since a stock does not always mimic the trajectory of the company’s financials because of other moving parts in the market.