Know how to use Piotroski’s F score for investments

By: |
January 29, 2021 1:00 AM

Piotroski’s F score looks at profitability, leverage liquidity and source of funding, and operating efficiency

Operating efficiency is measured using two sub-parameters such as gross profit margin (score of 1 if current year GPM is higher than that of the previous year, else zero) and asset turn (score of 1 if current year asset turn is higher than that of the previous year, else zero).

Piotroski’s F score classifies firms into three categories— weak candidates for investment (score in the range of 0-2), gray zone (score 3-7) and strong candidates (score of 8 or 9). The framework considers these sub-parameters: profitability, leverage, liquidity, and source of funding and operating efficiency.

Profitability is assessed using four sub-parameters such as return on assets (ROA) ( score of 1 if it is positive, else zero), cash from operations (CFO) (score of 1 if it is positive, else zero), accrual, i.e, whether the firm’s quality of earnings is good ( score of 1 if the ratio of CFO to net income is 1 or above 1, else score of zero) and change in ROA ( score of 1 if current year ROA is higher than that of previous year, else zero).

Look at ratios
Leverage liquidity and source of funding is evaluated with the help of three sub-parameters; namely, current ratio (score of 1 if current year ratio is higher than that of the previous year, else zero), long term debt (score of 1 if current year absolute amount of LTD is lower than that of the previous year, else zero) and equity issuance (score of 1 if there is no additional investment in equity capital, else zero).

Operating efficiency is measured using two sub-parameters such as gross profit margin (score of 1 if current year GPM is higher than that of the previous year, else zero) and asset turn (score of 1 if current year asset turn is higher than that of the previous year, else zero).

Let us assume that Abhijit Sagar, a management trainee, is interested in compute the F score for the calendar year ending on December 31, 2020. His ROA and CFO for the current year are positive and his ratio of CFO to net income is above 1 and his current year ROA is higher than that of the previous year. Therefore, he gets a score of 1 each for all the four sub-parameters of the profitability metric and his score is 4 out of 4 on profitability.

However, his current year current ratio is lower than the previous year. The amount of long-term borrowings is higher than that of the previous year. And he has not introduced additional equity capital in his entity. On leverage, liquidity and source of funding, he gets a score of only 1 out of the maximum obtainable score of 3. His cumulative score is 5 out of 8.

On operating efficiency, he scores quite poorly as his gross profit margin is lower compared to the previous year and his current year asset turn is also lower than the previous year. Therefore, he gets a score of zero for both the sub-parameters. And his cumulative score remains at 5.

Conclusion
Thus, Sagar’s total F score is 5 out of 9 which indicates that he is neither a weak performer nor a strong performer. So he is in the gray zone. The individual has done quite good in the profitability metric and he has performed poorly in the operating efficiency and leverage, liquidity, and source of funding parameters in which he needs to improve his F score.

The author is an associate professor of finance at XLRI School of Management, Jamshedpur

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, Check out latest IPO News, Best Performing IPOs, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1Last date for full and final settlement of bills to avail LTC Special Cash Package Scheme extended!
25 smart investment ideas for risk-averse investors to get higher returns
3Time for women to start protecting their financial health