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Piotroski Score: Understanding Its Definition, Application, and Examples in Finance

Last updated 03/28/2024 by

Alessandra Nicole

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Summary:
The Piotroski score, conceived by accounting professor Joseph Piotroski, is a numeric scale ranging from zero to nine, meticulously evaluating a company’s financial robustness. It serves as a tool for discerning value stocks, with a higher score indicative of a more resilient financial position. This article delves into the nine criteria behind the Piotroski score, its application, and considerations for investors in the finance industry.

What is the Piotroski score?

The Piotroski score, an invention by Joseph Piotroski, serves as a numeric gauge, providing a snapshot of a company’s financial health through nine distinct criteria. This article elucidates the intricacies of the Piotroski score, its derivation, and how it aids finance professionals in identifying value stocks.

Understanding the Piotroski Score

Profitability criteria

  1. Positive net income (1 point): A company earns a point for having positive net income, indicating profitability.
  2. Positive ROA (1 point): Another point is awarded if the return on assets (ROA) is positive in the current year.
  3. Positive operating cash flow (1 point): A positive operating cash flow in the current year contributes to the score.
  4. Cash flow from operations > net income (1 point): Quality of earnings is assessed by awarding a point if cash flow from operations surpasses net income.

Leverage, liquidity, and source of funds criteria

  1. Decreased leverage (1 point): A lower amount of long-term debt in the current period, compared to the previous year, contributes positively.
  2. Higher current ratio (1 point): An improved current ratio signifies more liquidity and adds to the score.
  3. No new shares issued (1 point): The absence of new share issuances in the last year prevents dilution and earns a point.

Operating efficiency criteria

  1. Higher gross margin (1 point): An increased gross margin compared to the previous year is considered a positive factor.
  2. Higher asset turnover ratio (1 point): A higher asset turnover ratio compared to the previous year adds to the score.

Evaluating the Score

A Piotroski score of 8 or 9 is indicative of a company in good financial standing, making it a potential value investment. Conversely, a score between 0-2 suggests a weaker financial position. Joseph Piotroski’s research demonstrated a 23% annual return between 1976 and 1996 by following this scoring method. It is worth noting that historical performance doesn’t guarantee future results, and investors should exercise due diligence.

Applying the Piotroski method: example with Foot Locker, Inc. (FL)

As an illustration, let’s examine the Piotroski scoring for Foot Locker, Inc. for fiscal year 2020:

Profitability calculation

  • Net income ($323,000,000) (Score: 1 point)
  • ROA (4.7%) (Score: 1 point)
  • Net operating cash flow ($696,000,000) (Score: 1 point)
  • Cash flow from operations ($696,000,000) > net income ($323,000,000) (Score: 1 point)

Leverage calculation

  • Long-term debt ($110,000,000) versus prior year’s long-term debt ($120,000,000) (Score: 1 point)
  • Current ratio (1.7) versus prior year’s current ratio (2.0) (Score: 0 points)
  • No new shares issued in 2020 (Score: 1 point)

Efficiency calculation

  • Gross margin (28.9%) versus prior year’s gross margin (31.8%) (Score: 0 points)
  • Asset turnover ratio (1.11) versus prior year’s (1.54) (Score: 0 points)
Foot Locker’s total Piotroski score in 2020 was 6 out of 9, suggesting an average value proposition.
WEIGH THE RISKS AND BENEFITS
Here is a list of the benefits and drawbacks to consider.
Pros
  • Provides a straightforward assessment of a company’s financial strength.
  • Valuable for finance professionals in identifying value stocks.
  • Easy to comprehend and apply in investment analysis.
Cons
  • Does not consider external market conditions or industry-specific trends.
  • Relies solely on historical financial data, which may not be indicative of future performance.

Frequently asked questions

What is the Piotroski score used for?

The Piotroski score is employed to assess a company’s financial strength, specifically aiding in the identification of value stocks by finance professionals.

How is the Piotroski score calculated?

The score is calculated based on nine criteria related to a company’s profitability, leverage, liquidity, and operating efficiency. Each met criterion earns one point.

What is considered a good Piotroski score?

A Piotroski score of 8 or 9 is deemed good, indicating a strong financial position. Conversely, a score of 0-2 suggests a weaker position.

Are there limitations to the Piotroski score?

Yes, the Piotroski score has limitations. It does not consider external market conditions or industry-specific trends, and its reliance on historical financial data may not accurately predict future performance.

Key takeaways

  • The Piotroski score evaluates a company’s financial strength on a scale of 0 to 9.
  • Named after Joseph Piotroski, the score considers nine criteria from financial statements.
  • A score of 8 or 9 indicates good value, while 0-2 suggests a weaker financial position.
  • Investors use the score to identify value stocks with strong fundamentals.
  • The method relies on historical financial data and may not predict future performance accurately.

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