Investing can feel like a game of chance, especially with the many factors that influence stock performance. To navigate this uncertainty, I rely on the Piotroski Score—a straightforward yet powerful tool that aids in evaluating the financial health of companies. In this post, I will explain what the Piotroski Score is, how it helps me select fundamentally strong stocks, and what scores suggest which companies to avoid.
What is the Piotroski Score?
The Piotroski Score, created by Stanford University professor Joseph Piotroski, is a rating system that assesses a company's financial strength using accounting data. The score ranges from 0 to 9, with 9 indicating peak financial health. It considers several financial metrics, including profitability, leverage, liquidity, and operating efficiency.
This tool is especially effective for value investors who want to uncover stocks appearing financially solid while trading at attractive prices.
How to Calculate the Piotroski Score
Calculating the Piotroski Score involves nine key criteria, divided into three categories:
Profitability:
Positive net income (1 point).
Positive operating cash flow (1 point).
Return on assets (ROA) must be greater than last year (1 point).
Quality of earnings must surpass net income (1 point).
Leverage, Liquidity, and Source of Funds:
A decline in long-term debt compared to last year (1 point).
Current ratio (current assets/current liabilities) must exceed last year's ratio (1 point).
The company should not have issued new shares in the last year (1 point).
Operating Efficiency:
Gross margin must be higher than last year (1 point).
Asset turnover (sales divided by average total assets) must also be higher than last year (1 point).
Each metric receives a score of 0 or 1, and the total gives the final score.
How to Use the Piotroski Score for Stock Selection
Utilizing the Piotroski Score is simple. Here’s how I incorporate it into my investment routine:
Screen for Value Stocks: I begin by identifying potential value stocks, often those with price-to-earnings ratios under 15.
Calculate the Score: I compute the Piotroski Score for each stock. A score of 8 to 9 suggests strong fundamentals. You can undertake calculations manually or use the Stocks to Buy app that calculates the Piotroski Score for your chosen stock. Open the app, register/login, then go to the Stock Type screen, input the stock ticker, and hit the Analyze button. Below is the example analysis that the app shows you.
Piotroski Score The first ticker OVV has a strong score of 8, suggesting that it is a Value Stock and together with high Growth Potential (target price exceeding market price by 25%) is a great stock for Long-Term hold.
Another ticker, APTV, has a lower Piotroski score of 5, suggesting that it has some space for improvement. Although it has high growth potential of 33%, it may not be a good idea for a longer term.
Research Further: After finding great shares with the help of the Stocks 2 Buy app, dive deeper and continue your research to make sure you will buy a company with a strong market position and a wide economic moat. Go to the company website, read the auditors’ notes, and read investment analysts’ research papers to see their forecasts and assumptions. And understand company's compettive advantage and market position.
Ongoing Monitoring: I continuously evaluate the financial health of my investments by recalculating Piotroski Scores and growth potential regularly.
This process helps me steer clear of overvalued or fundamentally weak companies that might initially seem appealing.
What Constitutes a Good vs. Bad Piotroski Score?
From my analysis, stocks scoring 8 or higher are generally strong buys. These companies show solid operational performance, profitability, and a sturdy financial structure. They also tend to have competitive advantages that help them outpace rivals.
In contrast, scores between 0 and 2 typically imply financial struggles, such as declining sales or high leverage. Stocks with these scores carry higher risks, so I rarely invest unless a strong turnaround story exists.
Companies to Avoid
Low Piotroski Scores often serve as a warning signal. Companies that consistently score below 3 deserve caution.
For instance, companies in volatile industries—like retail—facing high debt and underperformance can rank poorly. I typically avoid investing in firms with negative cash flow. Increased long-term debt without a solid repayment strategy is also a red flag. Although industries like utilities may have high debt levels, it's vital to understand the context of their financials.
The Piotroski Score has proven to be a valuable tool for navigating the landscape of stock investing. By emphasizing fundamentally strong stocks while avoiding those with signs of weakness, I feel better equipped to make smart investment decisions.
Employing the Piotroski Score into your analysis can help you identify stocks worth considering. By concentrating on companies with solid fundamentals, you set the stage for potential success in your investing journey.
Successful investing involves not just selecting stocks but understanding their underlying fundamentals. Happy investing!
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