We are often told to analyse financial statements/fundamentals before investing in a stock. But hardly anyone tells, how to analyse and what to analyse. In this blog we will explain a simple and well proven method to analyse a company’s financials, thanks to Professor Joseph Piotroski, for his Piotroski’s F score.
The F score segregates companies in 3 categories: Weak stocks (score b/w range of (0-2), Grey stocks (3-7) and Strong stocks (8 or 9). The score is based on the outcome of 3 parameters: a) profitability b) leverage, liquidity and source of funds and c) operating efficiency. The F-score is widely used as a screener by fund managers who invest in value stocks.
Profitability is measured via 4 sub parameters:
- Return on asset (ROA): If positive, score of 1 else 0
- Cash from operations (CFO): If positive, score of 1 else 0
- CFO/Net Profit: If >= 1, score of 1 else 0
- Current year ROA – Previous year ROA: If > 0, score of 1 else 0
Leverage, liquidity and source of funds is assed using 3 sub parameters:
- Present year current ratio/last year current ratio: If > 1, score of 1 else 0
- Present year long term debt/last year long term debt: If < 1, score of 1 else 0
- Equity issuance: If null in current year, score of 1, else 0
Operating efficiency is tested with the help of 2 sub parameters:
- Present year gross profit margin – last year gross profit margin: If > 0, score of 1 else 0
- Present year asset turnover – last year asset turnover: If > 0, score of 1 else 0
Overall F-score is the sum of 9 sub-parameters, with 9 being strongest and 0 being weakest. Historically, the companies screened via this method have given high returns to the shareholders’ in the long term.
If you look at latest earnings report of companies in the BSE500 then you may identify many companies with a score of 9. Some of them are: Aurobindo Pharma, Colgate, Emami, UPL, CESC, etc. A score of 9 solely doesn’t assure high investment return, as returns also depend on several other factors. But, you can certainly use the F-score as a guide for equity investment, wherein you should clearly avoid companies with a score of less than 2.
Hence, before buying any scrip, run the F-score to get an idea about its fundamentals. Further to ease your worries, we have developed an interactive excel sheet to calculate the F-score. Reply/Comment with your mail id, to have a copy of the same.
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