Piotrowski score

was devised by university of Chicago Accounting Professor, Joseph Piotroski reasoned that because value stocks are by definition often troubled companies, many will not possess the financial resources to recover. Consequently, Piotroski wondered if it was possible to improve the performance of a value stock portfolio by eliminating stocks that were the weakest financially. Piotroski devised a simple nine-criteria stock-scoring system for evaluating a stocks financial strength that could be determined using data solely from 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. Assumptions The research was specifically applied to low P/B firms. The average low P/B firm is financially distressed, so there is the implication that the firms in the research are financially distressed at some level.

This distress is associated with declining and/or persistently low margins, profits, cash flows, and liquidity and rising and/or high levels of financial leverage. The 9 financial variables chosen reflect the changes in these economic conditions so as to predict future firm performance. The implication of financial distress also meant that some variables should impact one way rather than the other (e.g. financial leverage can be impact positively or negatively in general, but for financially distressed firms it should impact negatively).

Score one point if a stock passes each test and zero if it doesnt. The maximum score is 9. 1. Net Income: Bottom line. Score 1 if last year net income is positive. 2. Operating Cash Flow: A better earnings gauge. Score 1 if last year cash flow is positive. 3. Return On Assets: Measures Profitability. Score 1 if last year ROA exceeds prior-year ROA. 4. Quality of Earnings: Warns of Accounting Tricks. Score 1 if last year operating cash flow exceeds net income. 5. 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.)

6. Current Ratio: Measures increasing working capital. Score 1 if CR has increased from the prior year. 7. Shares Outstanding: A Measure of potential dilution. Score 1 if the number of shares outstanding is no greater than the year-ago figure. 8. Gross Margin: A measure of improving competitive position. Score 1 if full-year GM exceeds the prior-year GM. 9. Asset Turnover: Measures productivity. Score 1 if the percentage increase in sales exceeds the percentage increase in total assets.