Purpose
The Piotroski F-Score is best understood as a value-trap filter. It does not identify whether a stock is cheap; it helps determine whether a cheap company’s underlying financial condition is improving or deteriorating.
The Nine F-Score Tests
A company receives one point for each test it passes.
| Category | One point when… | What it identifies |
|---|---|---|
| Profitability | ROA is positive | The company is profitable |
| Profitability | Operating cash flow is positive | Operations generate cash |
| Profitability trend | ROA increased year over year | Profitability is improving |
| Earnings quality | Operating cash flow exceeds net income | Earnings are supported by cash |
| Leverage | Long-term debt-to-assets decreased | Balance-sheet risk is falling |
| Liquidity | Current ratio increased | Short-term financial flexibility improved |
| Dilution | No new common shares were issued | Existing shareholders were not diluted |
| Efficiency | Gross margin increased | Pricing power or cost efficiency improved |
| Efficiency | Asset turnover increased | Assets are generating more revenue |
The score ranges from zero to nine. Piotroski intentionally made the tests binary so the score would be transparent and easy to implement.
| Score | Interpretation |
|---|---|
| 8–9 | Very strong fundamentals |
| 7 | Strong |
| 5–6 | Mixed/neutral |
| 3–4 | Weak |
| 0–2 | Very weak |
What The Original Study Found
Piotroski examined 14,043 high book-to-market firm-year observations from 1976 through 1996. It proved that an investment strategy which buys expected winners and shorts expected losers generated a 23% annual return between 1976 and 1996.
Importantly, this did not prove high-score companies almost always beat the market. In the original sample, only 50% did so.
Link to the Study: Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers
