University of Chicago Professor Piotroski created a nine criteria stock scoring system for evaluating a companies financial strength that could be determined from the financial statements. One point was awarded for each test that a stock passed. Piotroski classed any stocks that scored eight or nine points as being the strongest stocks. His findings were that these strong stocks as a group outperformed a portfolio of all value stocks by 7.5% annually over a 20-year test period. Piotroski also found that weak stocks, scoring two points or fewer, were five times more likely to either go bankrupt or delist due to financial problems.
Score one point if a stock passes each test and zero if it doesn’t. The maximum score is 9.
- Net Income: Bottom line. Score 1 if last year net income is positive.
- Operating Cash Flow: A better earnings gauge. Score 1 if last year cash flow is positive.
- Return On Assets: Measures Profitability. Score 1 if last year ROA exceeds prior-year ROA.
- Quality of Earnings: Warns of Accounting Tricks. Score 1 if last year operating cash flow exceeds net income.
- Long-Term Debt vs. Assets: Is Debt decreasing? Score 1 if the ratio of long-term debt to assets is down from the year-ago value. (If LTD is zero but assets are increasing, score 1 anyway.)
- Current Ratio: Measures increasing working capital. Score 1 if CR has increased from the prior year.
- Shares Outstanding: A Measure of potential dilution. Score 1 if the number of shares outstanding is no greater than the year-ago figure.
- Gross Margin: A measure of improving competitive position. Score 1 if full-year GM exceeds the prior-year GM.
- Asset Turnover: Measures productivity. Score 1 if the percentage increase in sales exceeds the percentage increase in total assets.
OldSchoolValue has a spreadsheet to compute the Piotroski score as well as a screener. Yesterday, I wrote about TJX companies as one of the three value ideas from thevalueguys.com. TJX has as Piotroski score of 8.