Piotroski Score: 9 Criteria for Analyzing Value Stocks

What Is the Piotroski Score?

The Piotroski Score is a powerful tool for assessing a company's financial strength and potential as a value investment. Named after Joseph Piotroski, this score ranges from 0 to 9, with higher scores suggesting stronger financial health. It uses nine specific criteria derived from financial statements to distinguish between strong and weak investment opportunities, offering critical insights for investors.

By examining recent accounting results, investors can determine value stocks, rewarding one point for each met criterion. This simple yet effective scoring system helps distinguish between strong and weak investments, with a higher score indicating a preferable value opportunity.

Understanding the Categories of the Piotroski Score

The Piotroski score is broken down into the following categories:

1. Profitability
2. Leverage, liquidity, and source of funds
3. Operating efficiency

Key Profitability Indicators in the Piotroski Score

• 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 being greater than net Income (quality of earnings) (1 point)

Evaluating Leverage, Liquidity, and Funding in the Piotroski Score

• Lower amount of 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 were issued in the last year (lack of dilution) (1 point).

Analyzing Operating Efficiency with the Piotroski Score

• A higher gross margin compared to the previous year (1 point)
• A higher asset turnover ratio compared to the previous year (1 point)

What Do Piotroski Score Numbers Reveal?

If a company has a score of 8 or 9, it is considered a good value. If the score adds up to between 0 and 2 points, the stock is considered weak.

In his April 2000 paper, Piotroski demonstrated that between 1976 and 1996, using the score method could yield a 23% annual return by buying stocks with high scores and shorting those with low scores.

Piotroski suggested beginning with stocks in the lowest 20% of the market based on price-to-book value.

As with any investment method, past outcomes don't guarantee future performance. If you want to learn more about the Piotroski score or other financial topics, consider taking a leading investing course.

Applying the Piotroski Score: Practical Example

Here's an example of using the Piotroski scoring method with the hypothetical company, XYZ. These are the profitability calculations:

• 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)

The leverage calculations are as follows:

• Long-term debt ($110,000,000) versus prior year's long-term debt ($120,000,000) (Score: 1 point)
• Current ratio (1.7) versus prior year's current ratio (2.0) (Score: 0 points)
• No new shares issued (Score: 1 point)

The efficiency calculations are as follows:

• Gross margin (28.9%) versus the prior year's gross margin (31.8%) (Score: 0 points)
• Asset turnover ratio (1.11) versus prior year's (1.54) (Score: 0 points)

XYZ scored 6 out of 9, indicating it's an average value option according to the Piotroski method.

Final Thoughts on the Piotroski Score

The Piotroski score is a powerful tool for identifying value stocks by assessing a company’s financial health. It uses nine specific criteria to measure aspects like net income, return on assets, operating cash flow, leverage, liquidity, and operating efficiency.

High scores (8-9) suggest strong value opportunities, while low scores (0-2) warn of potential financial troubles. Although historically successful, the score should be a starting point in stock analysis, combined with broader market considerations for informed investment decisions.