Piotroski F-Score Strategy: Backtest and Performance Analysis

The Piotroski F-Score strategy, developed by Joseph Piotroski, has gained widespread popularity among stock market investors. Many investors claim to use it for selecting stocks. You may have heard about the Piotroski F-Score, but do you know what it means and how to use it? Let’s find out what the Piotroski F-Score strategy is.

The Piotroski F-Score strategy is a stock selection method that uses financial analysis to identify undervalued stocks with strong fundamentals. The score is calculated based on 9 criteria, including profitability, liquidity, and efficiency, with stocks scoring 8 or 9 considered to have strong fundamentals. The strategy was developed by Joseph Piotroski, a finance professor at Stanford University, and has become a popular method for selecting stocks among investors.

In this post, we take a look at the Piotroski F-Score strategy. At the end of the article, we have provided several backtests.

Understanding the Piotroski F-Score Strategy

The Piotroski F-Score strategy is a stock selection method that evaluates a company’s financial health to determine whether a stock has strong fundamentals. Value investors often use it to find the best value stocks. The strategy was developed by Joseph Piotroski, a finance professor at Stanford University, and is based on the idea that companies with strong financials tend to outperform those with weaker financials.

The F-Score is calculated based on 9 financial criteria: profitability, liquidity, and efficiency. Each criterion is assigned a score of 1 or 0, with a higher score indicating stronger financials. The 9 criteria are:

1. Positive return on assets (ROA) in the last financial year
2. Positive cash flow from operations in the last financial year
3. Higher return on assets in the last financial year compared to the previous year
4. Cash flow from operations is higher than net income
5. Lower debt-to-total assets ratio in the last financial year compared to the previous year
6. A higher current ratio in the last financial year compared to the previous year
7. No issue of shares during the last year
8. Higher gross margins in the last financial year compared to the previous year
9. Higher asset turnover in the last financial year compared to the previous year

Stocks with a high F-Score (a score of 8 or 9) are considered to have strong financials, while those with a low score (0 to 4) are seen as stocks with poor financials. Using the Piotroski F-Score, investors can identify stocks likely to outperform the market based on their strong financial fundamentals.

While the Piotroski F-Score strategy has been commonly used for selecting value stocks, it has also proven to be a useful tool for growth stock selection. However, it is not a guarantee of success, and like any investment strategy, it’s important to use the Piotroski F-Score in conjunction with other tools and research to make informed investment decisions.

Exploring the Benefits of the Piotroski F-Score

The Piotroski F-Score has gained popularity among investors due to its simplicity and effectiveness. Here are some of the benefits of using the Piotroski F-Score:

• Objective analysis: The Piotroski F-Score strategy provides a clear, objective method for evaluating a company’s financial health. By using a set of 9 financial criteria, investors can quickly assess a company’s financial performance and determine whether a stock is undervalued.
• Outperformance: The Piotroski F-Score strategy has been shown to provide better returns than other stock selection methods. Companies with a high F-Score are considered to have strong financials, which can lead to better performance and higher returns.
• Low maintenance: The Piotroski F-Score strategy is easy to use and requires minimal maintenance. Investors simply need to calculate the F-Score for each stock they’re considering and use the score to determine whether to invest. Rebalancing can be done annually, for example.
• Reduces risk: By focusing on companies with strong financials, the Piotroski F-Score strategy helps to reduce risk in the stock market. Investing in companies with weak financials can be riskier, as they may be more likely to underperform or go bankrupt. This is one of the main takeaways from the research we have looked at.
• Portfolio diversification: The Piotroski F-Score strategy can be used to select a diverse range of stocks, which can help to reduce the overall risk of an investment portfolio. By investing in a mix of companies with strong financials, investors can benefit from better returns and reduced risk.

Establishing a Winning Investment Strategy with the Piotroski F-Score

Establishing a winning investment strategy with the Piotroski F-Score requires careful research and a systematic approach. Here are the steps to follow:

• Set investment goals: Before you start investing, it’s important to define your investment goals. Are you looking for short-term gains, long-term growth, or a combination of both? Knowing your goals will help you to determine the right investment strategy. The Piotroski F-score strategy is all about long-term investing. You need time for it to pan out.
• Research the market: To establish a winning investment strategy with the Piotroski F-Score, you need to have a good understanding of the stock market. Read financial news, research companies, and educate yourself on the various investment strategies available. To put faith in the Piotroski strategy and not fold during a drawdown, you need to truly understand it.
• Calculate the F-Score: Once you have a good understanding of the stock market, it’s time to start calculating the F-Score for each stock you’re interested in. The F-Score is calculated based on 9 financial criteria, including profitability, liquidity, and efficiency. Companies with a high F-Score are considered to have strong financials and to be undervalued.
• Make informed investment decisions: Use the F-Score as one of many tools to make informed investment decisions. It’s important to use the F-Score in conjunction with other research and analysis, such as earnings reports, analyst ratings, and stock charts, to determine the best stocks to invest in.
• Diversify your portfolio: Diversifying your portfolio is essential to reducing risk and maximizing returns. Consider investing in a mix of both growth and value stocks with high F-Scores, as well as other investment vehicles, such as bonds and mutual funds. The Piotroski strategy lets you buy many stocks and thus you should be reasonably diversified unless you end up overweight certain industries (which is likely).
• Monitor your investments: Regularly monitor your investments to ensure they are performing as expected. Reassess your investment strategy regularly, and make changes as needed, to ensure that you remain on track to achieve your investment goals.

Analyzing Financial Ratios with the Piotroski F-Score

Financial ratios are a key tool for evaluating a company’s financial performance and are used in the Piotroski F-Score to help determine a stock’s financial health and the potential for future growth. Here’s how to analyze financial ratios with the Piotroski F-Score:

• Identify the ratios: The Piotroski F-Score uses 9 financial ratios to assess a company’s financial performance. These ratios include profitability, liquidity, efficiency, and leverage.
• Obtain financial data: To calculate the financial ratios, you’ll need to obtain the relevant financial data for the company you’re interested in. This data is typically found in the company’s annual report or on financial websites. However, plenty of different websites let you scan based on the Piotroski criteria.
• Calculate the ratios: Once you have the financial data, you can start calculating the ratios. There are many online calculators and spreadsheet templates available to help with this step.
• Compare ratios to industry averages: To get a better understanding of a company’s financial performance, it’s important to compare its ratios to industry averages. This will give you a better idea of how the company is performing relative to its peers. There is a chance the scores make you overweight certain sectors of the market.
• Assess the trends: To determine the future potential of a stock, it’s important to look at the trends in a company’s financial ratios over time. Are the ratios improving or deteriorating?
• Use the ratios to get the F-Score: The Piotroski F-Score is calculated by adding up the number of positive financial ratios and assigning a score between 0 and 9. Companies with a high F-Score are considered to have strong financials and to be undervalued.

Applying the Piotroski F-Score to Maximize Returns

The Piotroski F-Score is a systematic and objective method for identifying undervalued and growth stocks with strong financials and maximizing returns. Here’s how to apply the Piotroski F-Score to maximize returns:

• Use the F-Score to identify stocks: Use the F-Score to identify stocks with strong financials. The higher the F-Score, the more attractive the stock is as an investment.
• Conduct further research: Once you’ve identified stocks with high F-Scores, it’s important to conduct further research to ensure they meet your investment criteria. Read earnings reports and analyst ratings, and consider the company’s management, growth prospects, and competition. Or, you could just trust the numbers and pick a basket of stocks with good Piotroski scores.
• Consider market trends: Consider the current market trends when making investment decisions. Is the market bullish or bearish? What sectors are performing well or poorly?
• Diversify your portfolio: You can diversify your portfolio by investing in a mix of both value and growth companies with high F-Scores, as well as in other investment vehicles, such as bonds and index funds.
• Periodically reassess your investments: You should have a schedule for reviewing your investments and making changes as needed, to ensure that you remain on track to achieve your investment goals.

Backtesting the Piotroski F-Score Strategy

Backtesting is the process of evaluating a trading strategy by analyzing its performance on historical data. It is an effective way to evaluate the Piotroski F-Score strategy’s potential performance and refine it to suit your investment goals. If you want to backtest the Piotroski F-Score strategy, here are the steps to take:

• Gather historical data: To backtest the Piotroski F-Score strategy, you’ll need access to historical financial data for the stocks you want to analyze. This data can be obtained from financial websites or from your broker. Several websites offer
• Calculate the F-Score: Use the 9 financial ratios used in the Piotroski F-Score to calculate the F-Score for each stock in your historical data set.
• Create a portfolio: Decide on the stocks you want to include in your portfolio and the weightings you want to give each stock. You will use the F-Score to help determine which stocks to include in your portfolio.
• Evaluate the results: Evaluate the performance of your portfolio over the chosen time frame. Look at the returns achieved, the volatility of the portfolio, and the overall risk profile.
• Refine the strategy: If necessary, refine your strategy by adjusting the weightings of your portfolio and adjusting the criteria for buying and selling stocks. Then you backtest again to see the performance with the new parameters.

Utilizing the Piotroski F-Score to Identify Value Stocks

The Piotroski F-Score is a powerful tool for identifying value stocks, which are stocks that are priced below their intrinsic value. Here’s how to use the Piotroski F-Score to identify value stocks:

1. Source financial data of many stocks: To calculate the F-Score, you’ll need access to financial data for the stocks you’re interested in. This data can be obtained from financial websites or from your broker.
2. Calculate the F-Score: Calculate the F-Score for each stock using the 9 financial ratios used in the Piotroski F-Score. The higher the F-Score, the more attractive the stock is as a value investment.
3. Identify undervalued stocks: Look for stocks with high F-Scores that are priced below their intrinsic value.
4. Conduct further research: Conduct further research on the value stocks you’ve identified. Read earnings reports and analyst ratings, and consider the company’s management, growth prospects, and competition.

Overall, using the Piotroski F-Score to identify value stocks is a systematic and objective way to find undervalued stocks with strong financials. By conducting further research, you can improve your odds of finding stocks that can make money in the long term.

Analyzing the Risk-Return Profile of the Piotroski F-Score

The risk-return profile of an investment strategy, such as the Piotroski F-Score, is an important consideration for investors. Here’s how to analyze the risk-return profile of the Piotroski F-Score:

• Calculate the historical returns: Use historical financial data to calculate the returns generated by the Piotroski F-Score strategy. Consider both the average return and the standard deviation of returns, which measures the amount of volatility in the returns.
• Assess risk: The risk associated with the Piotroski F-Score strategy can be influenced by market conditions, company performance, and other factors. Assessing the risk of each stock and the portfolio as a whole can help investors determine the level of risk they are comfortable with.
• Check the risk-adjusted ratios: To evaluate the market risk of high-scoring stocks, you can use risk-adjusted ratios such as the Sharpe ratio or the Treynor ratio. Risk-adjusted ratios play an important role in evaluating the risk-return profile of the Piotroski F-Score
• Consider other risk factors: Consider other factors that can affect the risk-return profile of the Piotroski F-Score strategy, such as market conditions, interest rates, and changes in the economy.
• Evaluate the risk-return trade-off: Compare the historical returns generated by the Piotroski F-Score strategy to the returns generated by other investment strategies and benchmark indexes, such as the S&P 500. Consider the risk-return trade-off, which measures the relationship between risk and return.
• Consider your personal risk tolerance: With what you have gathered, you can then reassess the strategy considering your personal risk tolerance, which is the amount of risk you’re comfortable taking on. It’s better to invest when you are at peace with the risk you are taking.

Implementing the Piotroski F-Score in a Portfolio

Implementing the Piotroski F-Score in a portfolio can help you identify undervalued stocks with a high potential for growth. Here’s how to implement the Piotroski F-Score in a portfolio:

• Determine your investment goals: Before implementing the Piotroski F-Score in your portfolio, determine your investment goals and risk tolerance. This will help you determine the type of stocks you should be looking for and the percentage of your portfolio that should be allocated to these stocks.
• Calculate the Piotroski F-Score: The Piotroski F-Score is calculated based on a series of financial ratios. Use a financial statement analysis tool or spreadsheet to calculate the Piotroski F-Score for the stocks in your portfolio.
• Identify high-scoring stocks: The Piotroski F-Score ranges from 0 to 9, with 9 being the highest possible score. Identify stocks that score 8 or 9 on the Piotroski F-Score to find high-quality, undervalued stocks.
• Conduct additional research: Before investing in a stock, conduct additional research to ensure it meets your investment goals and criteria. Consider factors such as the company’s financial performance, management, and industry trends.
• Select the stocks to invest in: Identify stocks that score well on the nine criteria of the Piotroski F-Score that also meet your other criteria and research findings.
• Diversify the portfolio: Diversify the portfolio by investing in a mix of both growth and value stocks that score well on the Piotroski F-Score criteria. Spread your portfolio across all market sectors. Consider using index funds. This helps reduce risk and improve returns.
• Monitor the portfolio: Regularly monitor the portfolio to ensure that the stocks continue to meet the Piotroski F-Score criteria. This can involve analyzing financial statements, company reports, and market trends, among other factors.
• Rebalance the portfolio: Rebalance the portfolio regularly to ensure that the weight of each stock remains in line with the investment strategy. This can involve selling underperforming stocks and investing in stocks that continue to meet the Piotroski F-Score criteria.

Using Backtesting to Evaluate the Piotroski F-Score Strategy

Backtesting is a valuable tool for evaluating the Piotroski F-Score strategy, as it allows investors to simulate the performance of their approach on historical data. The main uses of backtesting in evaluating the Piotroski F-Score strategy are:

• Assessing performance: By running the Piotroski F-Score strategy on historical data, you can assess its performance over a specific time period, including returns, risk, and the Sharpe ratio.
• Identifying strengths and weaknesses: Backtesting can reveal the strengths and weaknesses of the Piotroski F-Score strategy, allowing you to make improvements to your approach.
• Evaluating risk: Backtesting can help you assess the risk associated with the Piotroski F-Score strategy. For example, you can evaluate the maximum drawdown, or the largest drop in returns from peak to trough, to understand the risk involved.
• Refining the strategy: Based on the results of the backtesting, you can refine their approach to the Piotroski F-Score strategy. For example, you can adjust the criteria for buying and selling stocks, add or remove financial ratios, or consider different market conditions.
• Validating results: Backtesting can validate the results of the Piotroski F-Score strategy and provide confidence in its ability to generate returns in a live market environment.

In conclusion, the Piotroski F-Score strategy provides a simple and effective method for selecting stocks with good fundamentals. By focusing on companies with strong financials, you can benefit from better returns, reduced risk, and a more diversified portfolio. However, it is important to remember that while the Piotroski F-Score is a useful tool, it is not a guarantee of success. So, it should be used in conjunction with other research and analysis to make informed investment decisions.

Piotroski F-Score Strategy Backtest – Does It Work? Performance

Let’s look at recent empirical evidence and backtests that support the Piotroski F-score.

Alpha Architect tested the F-score on stocks listed on the New York Stock Exchange from 1974 to December 2014. They only included stocks that fall into the top 40% of the largest stocks by market value to avoid small-cap stocks.

Although they made a “new” F-score based on a few changes to the original Piotroski score, here’s the result with companies that scored at least 6 on the F-score:

The top line is Alpha Architect’s version of the F-score, the one in the middle is the original Piotroski score, and the bottom line is for the S&P 500. Source: Alpha Architect:

The chart shows that the gap between the S&P 500 and the two F-scores gets bigger as the years go by. The FS score, which is Alpha Architect’s version of the F-score, gave a 13.3% annual return; the Piotroski score gave 12.6%; while the S&P 500 gave 11.2%.

However, the standard deviation for all portfolios was more or less the same.

Alpha Architect also tested the F-score on cheap stocks. But only the 20% cheapest shares with a Piotroski score higher than 6 were included in the portfolio. The result is demonstrated in the chart below:

Source: Alpha Architect: Value Investing Research: Simple Methods to Improve the Piotroski F-Score

The annual return for Alpha Architect’s method was 15.9%; that of the Piotroski score was 15.2%; while that of the S&P 500 was 11.2%. The implication is that you can buy cheap stocks but only those with solid balance sheets and accounts.

Like Alpha Architect did on NYSE stocks, ValueSignals tested Piotroski scores on European stocks from June 1999 to 2011 without sorting by value. The result can be seen in the table below:

	Q1	Q2	Q3	Q4	Q5
Small-cap	205,1%	36,7%	-6,6%	-41,9%	-55,0%
Mid-cap	301,7%	82,7%	58,0%	3,0%	-54,6%
Large-cap	144,3%	77,1%	95,7%	61,3%	20,6%

Similarly, Alexander Eriksen, in his master’s thesis, studied Piotroski’s score and its variations on Norwegian and Swedish stocks. The study period is from 1997 to the end of 2011, with one annual rebalancing of the portfolios.

Eriksen studied three strategies: Piotroski’s method, a contrarian strategy, and a combination of Piotroski’s and contrarian stocks.

Within each of the three strategies, two equal portfolios were created, each with 10 stocks: a portfolio with assumed “good” stocks, and a portfolio with assumed “bad” stocks.

Eriksen’s results can be summarized as follows:

	‘Good’ Piotroski	‘Bad’ Piotroski	‘Good’ Contrarian	‘Bad’ Contrarian	‘Good’ Combined method	‘Bad’ Combined method
Annual Return	22,17%	-16,72%	45,82%	-12,9%	41,47%	-20,75%
Standard Deviation	29,54%	55,88%	40,52%	60,48%	36,06%	68,91%

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FAQ:

How does the Piotroski F-Score contribute to reducing risk?

Piotroski F-Score concentrates on objective analysis, potential for outperformance, low maintenance, risk reduction, and portfolio diversification.The strategy focuses on companies with strong financials, helping to reduce risk in the stock market compared to investing in companies with weaker financials.

How can I establish a winning investment strategy with the Piotroski F-Score?

The Piotroski F-Score strategy, developed by Joseph Piotroski, is a stock selection method that uses financial analysis to identify undervalued stocks with strong fundamentals. To establish a winning strategy, set investment goals, research the market, calculate the F-Score, make informed investment decisions, diversify your portfolio, and monitor your investments regularly.

How can I implement the Piotroski F-Score in my portfolio?

Implementing the strategy involves determining investment goals, calculating the F-Score, identifying high-scoring stocks, conducting additional research, selecting stocks to invest in, diversifying the portfolio, monitoring investments, and rebalancing regularly.