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Joseph Piotroski

Joseph Piotroski (Professor at the University of Chicago) came up with the idea of developing an investment formula that is quite successful.

His paper “Value Investing: the use of historical  financial information to separate winners from losers” was published in 2000.

 Piotroski : Value Investing: the use of historical  financial information to separate winners from losers

http://www.chicagobooth.edu/faculty/selectedpapers/sp84.pdf

In this paper he showed that by using a set of nine different fundamentals we could outperform the market by 10% a year on average from 1976 to 1996.

It is  clear that we were attracted to this formula and that we would implement this kind of screeners on our website.

Piotroski came up with a nine point scoring mechanism for stocks. It was designed to be applied to value investment in low P/B stocks (20% lowest P/B stocks) . This limits the strategy to true value companies. But it is useful for any set of stocks. (We have implemented the algorithm  also to the best 20% Magic Formula stocks and to the 20 % best NCAV companies)

Piotroski's methodology starts by narrowing stock choices to those trading in the top 20 percent of the market based on their book/market ratios (or, conversely, the bottom 20 percent of the market based on price/book ratios). He found that just buying low price/book stocks does not produce excess returns over the long term, because many low price/book companies are trading at a discount because they deserve to -- they're dogs with poor prospects. When he applied a series of additional tests of financial strength to these low price/book stocks, however, Piotroski was able to separate the dogs from the good prospects. Among the variables he examined: return on assets, current ratio, cash flow from operations, change in gross margin, and change in asset turnover. The strategy usually finds smaller companies whose stocks are flying under Wall Street's radar.

 Piotroski scanned the companies on the following basis; Financial performance, Leverage-liquidity, source of funds and Operating efficiency.

 Besides the price to book ratio, the analysis is based on accounting fundamentals and consists of awarding one point for each of the following tests:

1.positive earnings     [F_ROA]

2.positive cash-flow     [F_CFO]

3.increasing ROA    [F_ΔROA]  

4.Quality of earnings :Compare Cash flow return on assets (2) to return on assets (1) Score 1 if CFROA>ROA, 0 if CFROA < ROA      [F_ACCRUAL]

5.decreasing long-term debt as a proportion of total assets    [F_ΔLEVER]

6.increasing current ratio (indicating  an increasing ability to pay off short-term debt)[F_ΔLiquid]

7.decreasing or stable number of shares outstanding     [EQ­_OFFER]

8.increasing asset turnover (indicating an increasing sales as a proportion of total assets) [F_ΔTURN]

9.increasing gross margin     [Δ_MARGIN]

F_SCORE= F_ROA+ F_CFO+ F_ΔROA+ F_ACCRUAL+ F_ΔLEVER+ F_ΔLiquid+ EQ­_OFFER+ F_ΔTURN+ Δ_MARGIN

Each company is given either a one or a zero value on each variable.

The sum of the variables is F_SCORE (between 9 and 0).

Finally the companies are ranked from best to worst.

 Note:

The only difference between the  Piotroski formula  and our model is in evaluating the number of shares outstanding;

  • If the number of shares outstanding is stable we compute 0,5
  • the company buys back stock we compute 1
  • There will be a full coverage of the back-test made on either Greenblatt and Piotroski formulas.

 Go to the Joseph Piotroski Stock Screener