A simple approach to beat the market.
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In this video we look at the Piotroski F score and how impactful it can be for any trading or investing strategy.
Edward Croft, founder of Stockopedia, labelled it “The one indicator to rule them all”.
Before looking at the complexity, and to quickly highlight its ability, we see here a performance pareto from a research paper completed by Andrew Lapthorne, head analyst at Societe Generale.
The study covered more than two decades from 1985, and its conclusion strongly supported the F scores effectiveness.
The F score attributes a score from one to nine against a company, one being the lowest score and nine being the highest score.
We can clearly see a high correlation between the F scores, through either underperforming or outperforming the S&P 500 index.
For example, scores one to three largely underperformed the index by up to 10%, whereas scores from four to nine outperformed the index by between 5 and 18% on average. The incremental consistency at each score is far from coincidental… The correlation also exits between markets.
To look at the theory further, and to determine the viability of the F score in more recent times, I ran a simple back test from January 2000 to January 2022 using a starting balance of $100,000.
The rules were simple, to buy stocks with an F score of between 7 and 9, and to replace them should the F score drop to 4 or below.
Following this process would have yielded a return of almost 1000%, whereas the S&P 500 index grew by just 220%.
The ability to filter for fundamentally strong stocks with such a seemingly simple score, and with such predictability, is indeed remarkable.
let’s look behind the scenes of the F score and determine how these numbers are derived.
The score was created by Joseph Piotroski, a professor of accounting at Stanford University. The F score is made up of nine variables from a company’s financial statement. One point is awarded for each aspect which passes the criteria set.
The nine variables are split into three groups; Profitability, Leverage and Liquidity, and Operating Efficiency.
First, we have Net Income, if there is positive Net Income in the current year, the company gets one point.
Next, Operating Cashflow, positive cashflow is required from operations in the current year.
Return On Assets, current return on assets must be higher than the previous year.
Quality of Earnings, cashflow from operations must exceed Net income.
Decrease in leverage, If the ratio of long-term debt is lower than the previous year, we get one point.
Increase in liquidity, if the current ratio is higher this year than last year, we get one point.
Absence of dilution, one point is given if the company did not issue any new shares in the preceding year.
Next, we have Operating Efficiency.
If Gross Margin is higher than the previous year, we get one point, and finally, Asset Turnover, if there is a higher asset turnover ratio year on year, one point is given.
The key to these scores which is perhaps absent from other methods, is that we are looking for momentum within the aspects, with many of them looking for positive change from the previous year. This becomes particularly useful if you have a hybrid strategy like mine, combining technical momentum with fundamental momentum.
The part I like best about the F score is that there is no subjectivity involved, it either passes the question or it doesn’t, thereby providing a total score which can be easily filtered against.
I personally use Stockopedia for such analysis, and they provide detail for each stock based on the Piotroski F Score. For example, here we have the stock Apple, which has a total F score of 7.
We can look deeper into the score to see which questions failed to meet its criteria.
By clicking on the failed question, we are provided with additional information, and we can see that the debt ratio increased by 2.6% on the previous year, therefore failing the question and failing to achieve a point.
Further analysis is also available in the form of a bubble map, and this map enables us to identify Quality stocks showing momentum. Numerous studies have found that good quality stocks tend to outperform, and low-quality junk stocks tend to underperform.
Here we plot all the stocks filtered by Stockopedia which have the maximum F score of nine, and clearly we can see all the stocks have good quality fundamentals, and all showing momentum.
It begs the question, if we can easily filter for this type of stock through a simple scoring system, why would we not incorporate it into any strategy? Which in fact, is why I do….
Simply put, if we had a basket of stocks scoring one to four, which we know underperform, and a basket of stocks scoring seven or above, which we know outperform, which basket would you include in your strategy….
For those interested in digging further or perhaps screening for Piotroski F score stocks, I recommend Stockopedia, and have managed to negotiate a 25% discount for all viewers in the link below.
Thanks for watching and good luck…
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