Finding Value With The Piotroski F-Score

The following is part of a series originally published at the end of November on SeekingAlpha. The series was designed to test the effectiveness of the Piotroski F-Score in today’s market. The F-Score was designed to help investors outperform the market, but if it was really that good, surely everyone would be using it? The stocks below were selected using computer screens, no human interaction was involved, the stocks that qualified for the F-Score screen, entered the test portfolio.

I’ve always believed that computers are, and will always be, terrible at stock picking, and a human with experience is needed to pick out the ‘duds’ as it were from the results given by the computer….there’s also a need to double-check the computer data.

So the article was essentially an experiment, not a very scientific one granted, but an experiment nonetheless.

I will be updating on a monthly basis.

Finding Value With The Piotroski F-Score

First published on 20/11/2014

This is the first in what will be a series of articles looking at the investment performance of the Piotroski F-Score.

Finding value

In the world of value investing, there are many ways to hunt for value opportunities. However, few are as well defined as the Piotroski F-Score, which aims to identify the healthiest companies amongst a basket of value stocks through applying a set of nine accounting-based stock selection criteria.

The F-Score was designed to hunt out value opportunities that are profit-making, have improving margins, don’t employ any accounting tricks and have strengthening balance sheets. However, as usual, this strategy cannot be employed alone, it needs to be combined with another screening tool to produce a suitable set of results. One point is awarded for each criteria the company passes and the stocks that score the highest, eight, or nine are regarded as being the strongest candidates for recovery.

Piotroski recommended scoring the bottom 20% of the market in terms of price to book value and then working from there. Using the following system, Piotroski’s April 2000 paper Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers, demonstrated that the Piotroski score method would have seen a 23% annual return between 1976 and 1996 if the expected winners were bought and expected losers shorted. According to the American Association of Individual Investors, year to date the F-score screening criteria with a low P/B value would have returned 3.4%. Over the past five years this return would have been 33.9% and the ten-year return was 26.7%.

The screen

Throughout this series I’m testing the F-Score, as both a way to discover value stocks and trade them without fundamental analysis, the screening criteria and invests are based purely on the financials in an attempt to remove any emotional bias — something that holds back investment performance.

The F-Score screening criteria are as follows:

Profitability Signals

1. Net Income – Score 1 if there is positive net income in the current year.

2. Operating Cash Flow – Score 1 if there is positive cashflow from operations in the current year.

3. Return on Assets – Score 1 if the ROA is higher in the current period compared to the previous year.

4. Quality of Earnings – Score 1 if the cash flow from operations exceeds net income before extraordinary items.

Leverage, Liquidity and Source of Funds

5. Decrease in Leverage – Score 1 if there is a lower ratio of long term debt to in the current period compared value in the previous year.

6. Increase in Liquidity – Score 1 if there is a higher current ratio this year compared to the previous year.

7. Absence of Dilution – Score 1 if the Firm did not issue new shares/equity in the preceding year.

Operating Efficiency

8. Gross Margin – Score 1 if there is a higher gross margin compared to the previous year.

9. Asset Turnover – Score 1 if there is a higher asset turnover ratio year on year (as a measure of productivity).

And 20 companies that qualify in the current environment are as follows:

Criteria
Ticker Company 1 2 3 4 5 6 7 8 9 F-Score Price to book
1 (NYSE:NE) Noble 1 1 1 1 1 1 1 1 1 9 0.7
2 (NYSE:TX) Ternium SA 1 1 1 1 0 1 1 1 1 8 0.8
3 (NYSE:UNT) Unit 1 1 1 1 1 0 1 1 1 8 0.9
4 (NASDAQ:ORIG) Ocean Rig 1 1 1 1 0 1 1 1 1 8 0.6
5 (NYSE:CYS) CYS Investments 1 1 1 1 1 0 1 1 1 8 0.8
6 (NYSE:PACD) Pacific Drilling 1 1 1 1 1 0 1 1 1 8 0.6
7 (NYSE:HOS) Hornbeck Offshore Services Inc 1 1 1 1 1 1 1 0 1 8 0.8
8 (NYSE:OMG) OM Inc. 1 1 1 1 1 1 1 1 0 8 0.8
9 (NYSE:TRK) Speedy Motorsports 1 1 1 1 1 1 1 0 1 8 1
10 (NYSE:GLF) Gulfmark Offshore Inc 1 1 1 1 1 0 1 1 1 8 0.7
11 (NASDAQ:SCHN) Schnitzer Steel Industries Inc 1 1 1 1 0 0 1 1 1 7 0.8
12 (NYSE:BBG) Bill Barrett 0 1 1 1 1 1 1 1 1 8 0.7
13 (NYSE:PVA) Penn Virginia 1 1 1 1 1 1 0 1 1 8 0.6
14 (OTCQB:SXCL) Steel Excel Inc 1 1 1 1 1 0 1 1 1 8 0.8
15 (NYSE:MNI) McClatchy Co 1 1 1 1 0 1 1 1 1 8 0.9
16 (NYSE:DCO) Ducommun Inc 1 1 1 0 1 1 1 1 1 8 1
17 (NYSEMKT:VTG) Vantage Drilling Co 1 1 1 1 1 1 1 1 1 9 0.5
18 (NYSE:NES) Nuverra Environmental 0 1 1 1 1 1 1 1 1 8 0.5
19 (NASDAQ:WLFC) Willis Lease Finance 1 1 1 1 1 0 1 1 1 8 0.8
20 (NYSE:EARN) Ellington Residential Mortgage 1 1 1 1 1 0 1 1 1 8 1

P/B figures rounded to the nearest whole number.

To assess the F-Score I’m starting a hypothetical portfolio with a $1,000 investment in each company. Holdings will be sold when the P/B value exceeds 1.1. Investment prices are based on the closing price on 11/18/2014. These positions are based on financial data only, there’s no weighting to fundamental factors. I’ve decided to use this method in an attempt to take all of the emotion out of the trading and running of the portfolio, only when a stock qualifies under the set criteria will it be brought and it will be sold on the same basis.

A quick run through of the qualifying companies.

Noble

Even though Noble has been hit by an offshore drilling industry slowdown over the past few months the company’s low P/B and solid balance sheet helps it to qualify.

Ternium

Latin American steel producer, Ternium qualifies for every criteria apart from leverage. The company’s debt has increased this year, although a debt to equity ratio of 0.4 for a steel producer is hardly worrying.

Unit

Is a oil and natural gas contract drilling company and passes ever criteria apart from number six, an improving current ratio. The company’s current ratio currently stands at 0.6 according to Finviz.

Ocean Rig

Contract driller Ocean Rig is facing the same pressures as Noble. The company is currently trading below book and passes all of the F-Scores criteria apart from decreasing long-term debt. The company is still building up its fleet so long-term debt continues to rise.

CYS

Specialty finance company CYS invests in residential mortgage pass-through certificates in the United States. It also focuses on investing in residential mortgage-backed securities. The company passes all criteria apart from an improving current ratio.

Pacific Drilling

Pacific is yet another offshore driller that fits the F-Score bill. The company passes all of the criteria apart from the improving current ratio, which currently stands at 0.8.

Hornbeck Offshore Services

Hornbeck is not another driller but a supplier of offshore supply vessels and multi-purpose support vessels. Trading at a P/B of 0.8 the company passes eight of the nine F-Score criteria. The company falls criteria number eight as it gross margin is contracting.

OM Inc.

Operates as a specialty chemicals company producing chemicals for technology-driven industrial applications. The company passes all of the F-Score criteria but falls down on asset turnover, a measure of productivity. It seems as if the company is becoming less productive.

Speedy Motorsports

Speedy is one of the most expensive companies in the group trading at a P/B of 0.96. The company passes eight of the nine F-Score criteria falling down on number eight as the company’s gross margin is contracting.

Gulfmark Offshore Inc

Gulfmark is yet another provider of offshore marine support and transportation services. The company, like many of its peers in the sector trades at a low P/E of 0.7 and passes eight of the nine F-Score criteria. The company falls down on criteria number six, as its current ratio has not improved over the past year. That being said, at present the company has a current ratio of 2.5 so there’s nothing to worry about.

Schnitzer Steel Industries Inc

Schnitzer is the lowest scoring of the group, passing only seven of the nine F-Score criteria. The company has both, a rising level of long-term debt and a deteriorating current ratio. According to FinViz the company currently has a current ratio of 2.6 and a debt to equity ratio of 0.4.

Bill Barrett

Bill Barrett is an independent energy company, so the stock has fallen in line with the rest of the oil & gas sector. Still, as a recovery play on the sector the group appears to be well placed, it passes eight of the seven criteria and trades at a P/B of 0.7. Unfortunately, the criteria where Bill falls down is criteria number one: Score 1 if there is positive net income in the current year.

Penn Virginia

Penn is another independent energy producer. The company passes eight of the nine criteria falling at number seven: Absence of Dilution – Score 1 if the Firm did not issue new shares/equity in the preceding year. This could be a warning to potential investors that further dilution is down the line.

McClatchy Co

McClatchy publishes newspapers and related digital and direct marketing products in the United States. The company passes all criteria apart from criteria number five, as group debt is rising, not falling. Still, with a P/B of 0.9 and an F-Score of eight the company looks to be an interesting turnaround bet.

Ducommun Inc

Ducommun provides engineering and manufacturing products and services primarily to the aerospace, defense, industrial, natural resources, medical, and other industries. With a P/B of 1, the company is slightly expensive at present levels but it still trades below my P/B benchmark of 1.1. The company passes eight of the nine F-Score criteria, falling at number four, quality of earnings.

Vantage

Vantage is facing similar pressure to Noble but the company’s improving balance sheet and cash generative operations are helping it recover quickly.

Nuverra Environmental

Nuverra provides full-cycle environmental solutions to customers focused on the development and ongoing production of oil and natural gas from shale formations. The company is still loss making so only passes eight of the nine F-Score criteria, falling at the first hurdle. Nuverra trades at a P/B of 0.5.

Willis Lease Finance

Willis Lease Finance Corporation is engaged in leasing commercial aircraft engines and equipment worldwide. The company passes eight of the nine F-Score criteria, apart from number six, an improving current ratio.

Ellington Residential Mortgage

Ellington Residential Mortgage REIT, a real estate investment trust, which focuses on investing in residential mortgage-backed securities. The company passes all criteria apart from an improving current ratio.

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