Piotroski Model

What is the Piotroski Score?

A Piotroski Score is a financial metric developed by Joseph Piotroski, an accounting professor at the University of Chicago.

It is a tool used to assess and score a company’s financial health and fundamental strength based on a series of parameters.
Investors and analysts then use this score to help identify promising investment opportunities.

The Piotroski score ranges from 0 to 9 and a higher score indicates better financial health for the company.

The Piotroski Score is based on nine financial criteria, each of which receives a score of 1 if it meets a specific condition and 0
if it doesn’t.

These criteria include factors like profitability, leverage, operating efficiency, and the quality of earnings.

The final Piotroski score is derived by summing up these points and thereby understanding valuable insights into the
financial health of a company.

A high Piotroski Score suggests that a company may have sound financial fundamentals and is effectively managing its
resources. On the other hand, a low score may indicate financial red flags that warrant further investigation.

How to calculate a Piotroski score?

Calculating Piotroski Score involves assessing a company’s financial statements and assigning points based on specific criteria.
These criteria are broadly categorised under three heads namely:

1. Profitability

Category Score

Net Income Positive score (1) if the company has made net income in the current years, if not, negative score (0)

Operating Cash
Flow vs. Net Positive score (1) if the net income is higher, negative score (0) in other case.
Income

Return on Assets Positive Score (1) if the ROA is higher than the previous year, negative score (0) in other cases.

Operating Cash
A positive score (1) of operative cash flow is positive, negative score (0) is in other cases.
Flow

2. Leverage, Liquidity and Source of Funding

Category Score
 A positive score (1) if the debt levels decreased as compared to the previous year and in
Leverage
other cases, a negative score (0)

A positive score (1) if the current ratio has increased as compared to the previous year and in
Current Ratio
other cases, a negative score (0)

Change in the Number of A positive score (1) if the company has not issued any fresh equity in the previous year and
Shares Outstanding in other cases, a negative score (0)

3. Operational Efficiency

Category Score

Gross Margin Positive score (1) if the current year gross margin is higher than the previous year, if not, negative score (0)

Asset Turnover Positive score (1) if the current year asset turnover ratio is higher than the previous year, if not, negative score
Ratio (0)

How to use Piotroski score in stock picking?

The steps for stock picking using the Piotroski score are mentioned below.

 Companies with higher Piotroski Scores should be given priority by the investor.

 Companies with low Piotroski Scores should be subject to thorough investigation to understand the reasons behind
their scores.

 To make informed decisions, the investor should compare Piotroski Scores among companies within the same
industry.

 It is advisable for the investor to integrate the Piotroski Score with other analyses to get a comprehensive view.

 Maintaining a long-term investment perspective is essential when considering the Piotroski Score, as it reflects a
company’s fundamental health over time.

 Investors should regularly monitor and update the Piotroski Scores of the companies in their portfolio, as financial
health can change over time.
 Altman Z Score

Altman Z-score was developed by Edward Altman, Assistant Professor of Finance at New York University. First published in
1968, the score predicts a company's financial distress or the possibility of its going bankrupt within two years. The score
tries to predict the probability of companies becoming defaulters due to financial distress based on the current financial
statistics of the company.

Relying solely on the Altman Z-score is not a wise way to select stocks and there are many other metrics to be checked along
with this. A high Altman Z-score does not mean the companies are extremely safe and the scores are not comparable since
each company has its own unique metric and business model. Altman Z-score should be considered an approximate
measurement and is not intended to predict when a firm will actually file for legal bankruptcy. It is instead a measure of how
closely a firm resembles other firms that have filed

 The Altman Z-score is a formula for determining whether a company is headed for bankruptcy.
 The formula takes into account profitability, leverage, liquidity, solvency, and activity ratios.
 An Altman Z-score close to 0 suggests a company might be headed for bankruptcy or is in financial trouble, while a
score closer to 3 suggests a company is in solid financial positioning.
 Investors can use Altman Z-scores to determine whether they should buy or sell a stock if they're concerned about
the company's underlying financial strength. Investors may consider purchasing a stock if its Altman Z-Score value is
closer to 3 and selling or shorting a stock if the value is closer to 0

How to Calculate the Altman Z-Score

Z-score = (1.2×A) + (1.4×B) + (3.3×C) + (0.6×D) + (1.0×E)

where:

A= Working Capital ÷ Total Assets

B= Retained Earnings ÷ Total Assets

C= Earnings Before Interest & Tax ÷ Total Assets

D= Market Value of Equity ÷ Total Liabilities

E= Sales ÷ Total Assets