What is Piotroski Score: We have always used scores or ratings to rank and choose things. Whether it’s a movie that we are about to watch, an app that we are thinking of downloading, or a service that we’re willing to use, we make decisions based on scores.
Picking the right stocks for investment is one of the most critical tasks for an investor. Another task is to choose the right time to enter the market. In times of recession, only those companies that are fundamentally strong can sustain or beat the market.
Fundamental analysis and technical analysis help in making these decisions, but they are time-consuming.
Many of us wish that we could get scores and ranks to choose the companies that we have on our watchlist. It would be a great starting point for further analysis. In fact, there are a few comprehensive scores that tell us about various aspects of companies. In this article, we shall take a look at what is Piotroski Score and how is it used.
What is Piotroski Score?
Piotroski Score is an instant metric for screening stocks. Often used to find value stocks, it reflects the strength of a company’s financial position. The score is based on nine parameters. One point is awarded for every parameter that is met. A Piotroski Score of nine is the best, while zero is the worst.
The Origin of the Piotroski Score
The Piotroski Score was first published by Chicago Accounting Professor Joseph Piotroski in the year 2000. He devised the scale based on specific aspects of company financial statements.
These aspects are focused on the company’s accounting results in recent time periods (years). The score broadly covers profitability, leverage, liquidity, source of funds, and operating efficiency.
Breaking down the Piotroski Score
The following parameters make up the Piotroski score:
| Parameter | What it measures | Score |
|---|---|---|
| Net Income | Has the company made a profit during the current year | Positive = +1, Negative = 0 |
| Operating Cash Flow | Indicates cash flow after adding depreciation to net income and making adjustments for changes in account receivables and inventory | Positive = +1, Negative = 0 |
| Return on Assets | How well is the management is employing the company’s total assets to make a profit. | More than the previous year = +1, otherwise 0 |
| Operating Cash Flow vs Net Income | When operating cash flow is less than net income, what is the quality of the company's earnings based on its profit realization and after excluding non cash items. |
Operating Cash Flow > Net Income = +1, else 0 |
| Leverage or gearing | How much of the company's assets are financed by debt? | More than the previous year = +1, otherwise 0 |
| Current Ratio | Can the company repay its short-term liabilities with its short-term assets. | More than the previous year = +1, otherwise 0 |
| Outstanding Shares | Can the company grow without diluting its shares | No fresh issue = +1 Fresh Issue = 0 |
| Gross Margin | What percentage of the total sales does a company retain after incurring direct costs? | More than the previous year = +1, otherwise 0 |
| Asset Turnover Ratio | How efficiently does a company use its assets? | More than the previous year = +1, otherwise 0 |
The Piotroski Score gives a sound comparison of companies based on their previous performance. In general, a score of 7 to 9 is considered to be good. On the other hand, a score of 0 to 2 is considered to be bad.
The score is based on the recent performance of a company. It points out current outperformers on the basis of profitability and financial improvements. Therefore, if a company has a low Piotroski score, it does not necessarily mean that its financial position is weak. It means that the company has not performed well recently.
Piotroski Score of Companies
A few large-cap companies with a high Piotroski score of 9, on 18th October 2022, were JSW Steel, Vedanta, Ambuja Cements, DLF, and Tata Consumer Products. Further, there were a few large-cap companies with a Piotroski Score between three and six.
These include Reliance Industries, Bajaj Finance, HDFC, Kotak Mahindra Bank and Adani Enterprises. Another large-cap company, Wipro has a Piotroski score of two.
Limitations
The Piotroski Score is a great tool to get a headstart in analyzing multiple stocks, however, it has the following limitations:
- It compares the performance of companies based on the previous year’s data. Therefore, there is a chance that it might show that high-quality stocks are not that great. This is especially true in the case of cyclical stocks and when unusual events like the pandemic affect the markets.
- The reverse of the above-mentioned limitation is also possible. For example, the Piotroski score is high for most companies in 2021 because of a rebound after a poor performance in 2020 (during the pandemic). It becomes difficult to trust the metric in such situations due to recency bias. Therefore, the Piotroski scores of multiple years are to be considered to find consistent performers.
- Further, this metric is not quite useful if we are analyzing micro-cap stocks. These stocks have a market capitalization below ₹ 500 crores and lack liquidity as compared to small-cap, mid-cap or large-cap stocks. Therefore, even quality stocks in this segment might give negative or low returns.
In Closing
The Piotroski score is a great metric to start analysis, especially when DIY investors are just starting out. However, it does not replace a thorough fundamental analysis of a company.
Even though we can screen stocks using this metric, we have to consider factors like a company’s business model, the industry that it functions in, its performance with respect to its competitors, and its financials.
That’s all for this article on what is Piotroski score. We hope to see you around and happy investing until next time!
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