Decoding the Piotroski Score: What Is It, How Is It Calculated and An Example

Kiran Shroff
Decoding the Piotroski Score: What Is It, How Is It Calculated and An Example

The Piotroski Score is a method created by a professor named Joseph Piotroski to help investors find good companies with strong financial performance.

The Piotroski Score is a method created by a professor named Joseph Piotroski to help investors find good companies with strong financial performance. It gives a score from 0 to 9 based on nine simple checks from a company’s financial reports. A high score means the company is financially healthy, making it popular for people who look for undervalued stocks.

 

What Is the Piotroski Score?

The Piotroski Score is a way to measure how strong a company’s finances are. It helps investors spot companies that are undervalued but still have solid financials. The nine checks fall into three groups:

  1. Profitability
  2. Debt, Liquidity, and Financing
  3. Efficiency in Operations

A company gets 1 point for meeting each check and 0 if it doesn’t. This means a company can score anywhere between 0 (weak financial health) and 9 (very strong financial health).

 

How Is the Piotroski Score Calculated?

Profitability Checks (Up to 4 Points)

  1. Positive Net Income: 1 point if the company made a profit.
  2. Positive Return on Assets (ROA): 1 point if ROA, which shows how well a company uses its assets, is positive.
  3. Positive Operating Cash Flow (OCF): 1 point if the company’s cash flow is positive.
  4. OCF Greater Than Net Income: 1 point if cash flow is higher than profit, showing good-quality earnings.

Debt, Liquidity, and Financing Checks (Up to 3 Points)

  1. Lower Debt Levels: 1 point if long-term debt decreased from the previous year.
  2. Improved Current Ratio: 1 point if the ratio of assets to liabilities improved, showing better liquidity.
  3. No New Shares Issued: 1 point if the company didn’t issue more shares, avoiding dilution of ownership.

Efficiency Checks (Up to 2 Points)

  1. Improved Gross Margin: 1 point if the company’s gross margin (profit after production costs) improved.
  2. Higher Asset Turnover: 1 point if the company is using its assets more efficiently to generate revenue.

The final score is the total points from these nine checks.

 

Interpreting the Piotroski Score

  • 8-9 Points: Very strong financial health; good potential for investment.
  • 4-7 Points: Moderate health; further review is needed.
  • 0-3 Points: Weak financial health; likely not a good investment.

 

Advantages of the Piotroski Score

  1. Simple to Use: Easy to calculate and understand.
  2. Focuses on Fundamentals: Looks at key financial strengths.
  3. Historically Reliable: Studies show that high-scoring companies often perform better.
  4. Saves Time: Quickly gives a snapshot of financial health.

 

Disadvantages of the Piotroski Score

  1. Based on Past Data: It doesn’t predict future market changes or performance.
  2. Narrow Focus: Covers only nine aspects, ignoring things like market trends or other qualitative factors.
  3. Not Always Accurate: Can misrepresent cyclical companies or small, less-liquid stocks.
  4. Needs Support: Works best when combined with other analysis tools.

 

An Example Calculation

Let’s look at a fictional company, ABC Ltd, for the years 2024 and 2023:

Financial Data

Metric

2023

2024

Net Income

Rs 1.5 crore

Rs 2.2 crore

Total Assets

Rs 50 crore

Rs 55 crore

Operating Cash Flow (OCF)

Rs 1.8 crore

Rs 2.5 crore

Long-Term Debt

Rs 10 crore

Rs 8 crore

Current Ratio

1.2

1.5

Outstanding Shares

10 crore

10 crore

Gross Margin

0.4

0.45

Revenue

Rs 20 crore

Rs 25 crore

Asset Turnover Ratio

0.4

0.45

Step-by-Step Calculation

  1. Profitability:
    • Positive Net Income: Yes (1 point).
    • Positive ROA: Yes (Rs 2.2 crore / Rs 50 crore = 4.4 per cent) (1 point).
    • Positive OCF: Yes (Rs 2.5 crore) (1 point).
    • OCF > Net Income: Yes (Rs 2.5 crore > Rs 2.2 crore) (1 point).
    • Total Profitability Points: 4
  2. Debt, Liquidity and Financing:
    • Lower Debt Levels: Yes (Rs 10 crore to Rs 8 crore) (1 point).
    • Improved Current Ratio: Yes (1.2 to 1.5) (1 point).
    • No New Shares Issued: Yes (10 crore shares unchanged) (1 point).
    • Total Debt/Liquidity Points: 3
  3. Efficiency:
    • Improved Gross Margin: Yes (40 per cent to 45 per cent) (1 point).
    • Higher Asset Turnover: Yes (0.4 to 0.45) (1 point).
    • Total Efficiency Points: 2

Final Piotroski Score: 4 (Profitability) + 3 (Debt/Liquidity) + 2 (Efficiency) = 9

Interpretation

ABC Ltd scores a perfect 9, showing excellent financial health and strong investment potential.

Conclusion

The Piotroski Score is a helpful way to find financially strong companies, especially for beginners or value investors. While it has limits, using it with other tools can make it even more effective. By focusing on key areas like profitability, debt, and efficiency, it makes understanding a company’s financial health easier for everyone.

Disclaimer: The article is for informational purposes only and not investment advice. 

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