Pitroski F-Score

Embedded in that mix of companies, you have some that are just stellar. Their performance turns around. People become optimistic about the stock, and it really takes off [but] half of the firms languish; they continue to perform poorly and eventually de-list or enter bankruptcy.”
-- Joseph Piotroski, University of Chicago Accounting Professor

Pitroski want weed out the poor performers and identify the winners in advance.

He devised a simple nine-criteria stock-scoring system called the Pitroski F-Score, for evaluating a stock’s financial strength that could be determined using data solely from financial statements as below.

1.  Net Income: Bottom line. Score 1 if last year net income is positive.

1. Operating Cash Flow: A better earnings gauge. Score 1 if last year cash flow is positive.   

1. Return On Assets: Measures Profitability. Score 1 if last year ROA exceeds prior-year ROA.  

1. Quality of Earnings: Warns of Accounting Tricks. Score 1 if last year operating cash flow exceeds net income.

1. 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.)

1. Current Ratio:  Measures increasing working capital. Score 1 if CR has increased from the prior year.    

1. Shares Outstanding: A Measure of potential dilution. Score 1 if the number of shares outstanding is no greater than the year-ago figure.

1. Gross Margin: A measure of improving competitive position. Score 1 if full-year GM exceeds the prior-year GM.

1. Asset Turnover: Measures productivity. Score 1 if the percentage increase in sales exceeds the percentage increase in total assets.

 The interpretation...

• 8 - 9: Strongest Stock

• <= 2 : Weakest Stocks

Pitroski  made clear that the paper "does not purport to find the optimal set of financial ratios for evaluating the performance prospects of individual “value” firms" - rather, it is just one way that investors can use relevant historical information to eliminate firms with poor future prospects from a generic value portfolio.

It is not useful to check stock selected by

• Magic Formula -  buying good companies at good price

• Graham NCAV or NNWC

It will be a useful weapon if you want to 

• listen to some rumours from your remisiers, friends, internet forums of insiders going to pump up the share price (purportedly for your benefits) of some crappy stocks 

• ride on the band wagon on the turnaround stories

 Even that, one must exercise good judgment.

References:-

• Pitroski F-Score, the Altman Z-Score and the Beneish M-Score kcchongnz (private)
• Buying bargains on the mend kcchongnz (private)
• Value Investing: The use of historical financial statement information to separate winners from losers