Piotroski Score- What it is, components and Interpretataion

Piotroski Score

Key Highlights

The Piotroski Score is a financial metric used to evaluate the financial health and potential value of a company.
It was developed by Joseph D. Piotroski, an accounting professor at the University of Chicago, and introduced in a paper published in 2000.

What is Piotroski Score?

The Piotroski Score is a financial metric used to evaluate the financial health and potential value of a company. It was developed by Joseph D. Piotroski, an accounting professor at the University of Chicago, and introduced in a paper published in 2000. The score is specifically designed to identify undervalued companies that are financially strong within the universe of value stocks, particularly those with low price-to-book ratios.

Components of the Piotroski Score

The Piotroski Score is calculated based on nine criteria, which are grouped into three categories: profitability, leverage/liquidity, and operating efficiency. Each criterion is binary, meaning the company either meets it (scored as 1) or does not (scored as 0). The total score ranges from 0 to 9, with higher scores indicating stronger financial health.

1. Profitability:

Net Income: Positive for the current year.
ROA: Positive return on assets.
CFO: Positive operating cash flow.
Accruals: CFO exceeds net income, indicating high-quality earnings.

2. Leverage, Liquidity, and Source of Funds:

Leverage: Lower long-term debt ratio.
Current Ratio: Higher current ratio.
Shares Outstanding: No new shares issued, avoiding equity dilution.

3. Operating Efficiency:

Gross Margin: Improved from the previous year.
Asset Turnover: Enhanced asset turnover, reflecting better use of assets to generate revenue.

Interpretation of the Piotroski Score

Score of 8-9: Indicates a strong financial position and suggests the company is likely undervalued, making it a potentially good investment opportunity.
Score of 5-7: Indicates average financial health. These companies may be stable, but further analysis is needed before making investment decisions.
Score of 0-4: Indicates weak financial health, suggesting that the company may be at risk of financial distress and might not be a good investment.

The Piotroski Score is often used by value investors as part of a broader investment strategy. It helps in filtering out weak companies from a list of potential investments, focusing on those that are financially sound and likely to generate positive returns.