Piotroski Score: A Simple Fundamental Analysis Tool

The Piotroski Score, named after its creator Joseph Piotroski, is a financial scoring system used to evaluate the financial strength of a company. The score is based on nine financial indicators and is designed to help investors identify companies with strong fundamental performance. Each indicator receives a score of 0 or 1, and the total Piotroski Score is the sum of these individual scores.

Understanding the Piotroski Score

The Piotroski Score is a discrete scale ranging from 0 to 9, which assesses a firm’s financial viability based on nine criteria. These criteria are divided into three categories: profitability, leverage and liquidity, and operating efficiency.

A high Piotroski Score of 8 or 9 signifies a financially robust company, likely undervalued by the market. Conversely, a score of 2 or below suggests a company with weak financials, is potentially overvalued.

In much simpler terms you have a report card for a company, and the Piotroski Score is like the grade on that report card. The score is made up of nine different grades, and each grade tells us something about how well the company is doing.

Here are the 9 criteria that make up the Piotroski Score:

• Good at Making Money (Return on Assets): This grade tells us if the company is good at making money. This measures how effectively management is using all of the company’s resources to turn a profit. If it is, it gets a point, if not, it gets zero.
• Improving Profit (Net Income Margin): This grade checks if the company is making more profit compared to last year. This measures how much extra the company is earning over its expenses and taxes. If it is positive, it gets a point.
• Using Resources Well (Asset Turnover): This grade looks at how well the company is using its stuff to make money. This measures how efficiently a company is using its assets to produce revenue. If it’s doing better than last year, it gets a point.
• Not Borrowing Too Much Money (Leverage): This grade checks if the company is borrowing too much money. It measures the long-term debt of the company compared to its previous year. If it’s borrowing less compared to last year, it gets a point.
• Having Enough Money for Now (Current Ratio): This grade looks at whether the company has enough money to pay its bills. It measures liquidity of the firm; high liquidity helps a company to be cash-rich. If it has more than last year, it gets a point.
• Not Creating Too Many New Shares: This grade checks if the company is making more shares. This means that the company is not diluting the share of existing shareholders which impacts the earnings per share. If it’s not, it gets a point.
• Making More Money from Sales (Gross Margin): This grade looks at whether the company is making more money from selling things. If the company is making sales over its direct expenses, then it is marked as a good sign. If it is, it gets a point.
• Making Money in a Good Way (Operating Cash Flow): This grade looks at whether the company is making money in a good way. This measures that the company is actually bringing the profit through its core business or something else. If it is, it gets a point.

Know: The Power of Free Cash Flow

Scoring With the Piotroski Method

Piotroski’s research showed that investing in companies with high scores and shorting those with low scores would have yielded a 23% annual return from 1976 to 1996. The Piotroski Score combs through a pool of low price-to-book stocks, isolating those with solid financials and avoiding value traps.

Piotroski Score encourages a focus on long-term financial stability and operational efficiency, rather than short-term price movements and it is particularly useful in identifying opportunities in bear markets or sectors in distress, where fundamentally strong companies may be undervalued. It’s also beneficial in bull markets to avoid overhyped stocks with weak financials.

As an example of the Piotroski scoring method in action, note the following criteria calculations for Relaxo Footwear Ltd for fiscal year 2023. The profitability calculation was as follows:

Relaxo Footwear Ltd “2023 Annual Report.” Accessed November 16, 2023.

The profitability calculation was as follows:
Net income (Rs 2,783 Crore) (Score:1 point)
ROA (6.41%) (Score: 1 point)
Net operating cash flow (Rs 3 Crores) (Score: 1 point)
Cash flow from operations (Rs 345 crore) > net income (Rs 2,783 Crore) (Score: 0 point)

The leverage calculation was as follows:
Long-term debt (Rs. 225 Crore) versus the prior year’s long-term debt (Rs 164 crore) (Score: 0 point)
Current ratio (2.26) versus prior year’s current ratio (2.57) (Score: 0 points)
Negligible number of new shares issued in 2023 (Score: 1 point)

The efficiency calculation was as follows:
Gross margin (16%) versus prior year’s gross margin (12%) (Score: 0 points)
Asset turnover ratio (1.14) versus prior year’s (1.16) (Score: 0 points)

Relaxo Footwear’s total Piotroski score in 2023 is s 4 out of 9 which shows the company’s fundamentals are not that much strong.

Read: How to Read Annual Report of Any Company?

Interpretation of Piotroski Score

• 8-9: Companies with scores in this range are often considered to have strong fundamentals. These companies typically exhibit positive financial indicators across various criteria, reflecting sound financial health and potential for investment. The companies with 8-9 score reflect that those are doing well Profitability wise, efficiency-wise, Liquidities and also managing the debt in strategic manner.
• 6-7: Scores in this range suggest that a company has relatively solid fundamentals but might have some areas that could be improved. Investors may consider additional factors before making investment decisions.
• 0-5: Lower scores are generally associated with companies that may have weaker financial conditions or are facing challenges.

Following are Top 5 High Piotroski stocks by Market Capitalization:

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.