This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.
Sorting cheap stocks
Value investors buy companies that look cheap compared with their book value. Many of them are cheap for a reason: they are in financial trouble. In 2000, accounting professor Joseph Piotroski, then at the University of Chicago and now at Stanford, proposed a simple way to separate the healthy ones from the weak: nine yes-or-no tests on the latest annual accounts, each worth one point. The total, from 0 to 9, is the F-score.
The nine tests
Profitability (4 points)
- Net income is positive, so return on assets (ROA) is above zero.
- Cash flow from operations is positive.
- ROA is higher than the year before.
- Cash flow from operations is larger than net income, a sign that profits are not inflated by accounting accruals.
Leverage, liquidity and source of funds (3 points)
- Long-term debt as a share of total assets fell compared with the year before.
- The current ratio, current assets ÷ current liabilities, rose.
- The company did not issue new common shares during the year.
Operating efficiency (2 points)
- Gross margin is higher than the year before.
- Asset turnover, sales ÷ total assets, is higher than the year before.
Example
A company is profitable, generates positive and growing cash flow above its net income, reduced its debt ratio, issued no new shares and improved its gross margin, but its current ratio and asset turnover slipped. It passes 7 of 9 tests: 4 for profitability, 2 for leverage and liquidity and 1 for efficiency.
Reading the score
- 8 or 9: strong. Profits are rising, backed by cash, and the balance sheet is improving.
- 3 to 7: average. Look at which tests fail and why.
- 0 to 2: weak. Falling profits, poor cash generation or growing debt.
In Piotroski’s original study of U.S. stocks with a low price-to-book ratio from 1976 to 1996, buying the high scorers and shorting the low scorers produced a return of about 23% a year. Later research found the effect smaller and concentrated in small companies, but the score remains a popular screening tool.
Limits
The score uses simple year-on-year changes, so one unusual year can flip several tests. It ignores valuation, which is why it is usually applied to a list of stocks already screened as cheap. It is less meaningful for banks and insurers, whose balance sheets work differently, and for young companies with no profits yet.
Where to get the data
All nine items come from the last two annual reports, Form 10-K for U.S. companies: the income statement, the balance sheet and the cash flow statement. Use the same fiscal year end for both years.