The Piotroski F-Score can help investors cut through the numbers and identify high-quality stocks. Ben Hobson explains how.
Ten stocks scoring well against this financial health checklist
At a time when the outlook for many firms is deeply uncertain, how can you know the difference between a business in decline and one that’s on a solid footing?
For investors, the fact is that some apparently broken companies can, and do, come roaring back to life. Meanwhile, others with seemingly no obvious problems can suddenly find themselves in terminal decline.
What’s needed is a financial health checklist that can detect the important signs of strong and improving financial health. And that’s where something called the Piotroski F-Score comes in...
In search of solid fundamentals
The F-Score was first introduced in 2000 in a research paper by an accounting professor called Joseph Piotroski. His initial aim was to understand which stocks at the very cheapest end of the market were best placed to recover. But his methodology was quickly picked up and applied as a general rule-of-thumb for finding high quality shares anywhere in the market.
Piotroski had created a nine-point accounting checklist - the higher the score out of nine, the better the financial health trend of the stock. Importantly, it was designed to look back over a company’s previous accounts and detect the most important clues to improvement or deterioration.
The nine checks are spread between three key areas of financial analysis. The first is profitability, where the F-Score looks at operating profits and cash flow to see if the business can sustain itself and even pay dividends. These checks look for an improving trend in profitability, which can be a sign that a turnaround is underway in underpriced and potentially misunderstood shares.
Three of the nine F-Score checks look at the capital structure of the business. These look for potential red flags over the health of the balance sheet. They assess whether the company is improving its capacity to service both long and short term debt, or if it is having to fund operations by issuing more shares.
Finally, the F-Score looks at whether the firm’s operating efficiency is improving by looking for improvements in gross margins and asset turnover.
A checklist for any occasion
In his own studies, which applied the F-Score to cheap shares, Piotroski’s tests found that those with the highest financial strength often went on to outperform - on average by 7.5% annually over a 20 year backtest. Over time, his checklist was picked up by investment banks and equity analysts across a wide range of strategies to great effect.
To get an idea of the types of companies with the highest F-Scores in the market right now we adapted the screen for Interactive Investor. The table includes the relative price strength of each share against the market over the past year to give you an idea of how it has performed.
|Name||Mkt Cap £m||Piotroski F-Score||1 Year Relative Strength||Sector|
|Ultra Electronics (LSE:ULE)||1,703||9||53.8||Industrials|
|Lenta (LSE:LNTA)||1,083||9||6.37||Consumer Defensives|
|Greencore (LSE:GNC)||568||8||-27.1||Consumer Defensives|
|AO World (LSE:AO.)||808.7||8||184.3||Technology|
The results range from small-caps like Eleco (LSE:ELCO) and Cerillion (LSE:CER) to mid- and large-cap shares like Ultra Electronics (LSE:ULE), Lenta (LSE:LNTA) and AO World (LSE:AO.). All of them bar the food group Greencore (LSE:GNC), outperformed the market over the past year.
Overall, Piotroski’s F-Score is a handy checklist for investors looking for an instant assessment of a company’s financial health trend. High scoring firms tend to be strong, stable and profitable, with the potential to deliver predictable returns. This assessment of fundamental health won’t always provide protection from trouble, but for those looking for a way of assessing the trends in a company’s financial track record, the F-Score could be a useful place to start.
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