The F-Score, developed by university professor, Joseph Piotroski, scores companies on a list of nine parameters related to profitability, operating efficiency and leverage.

I screened for stocks with a perfect score of 9 for the F-Score and a P/B ratio of less than 1. Three stocks, MOD-PAC Corp. (MPAC), P&F Industries Inc. (PFIN) and Nortel Inversora S.A. (NTL) passed the test with flying colors. As a result, I found imperfections with the F-Score that I would like to share with readers.

Firstly, the F-Score focuses on improvement, rather than absolute levels. MPAC improved its gross profit margin from 17.14% in the previous year to 17.63% this year. The increase of 0.49% in gross margin and 17% gross margin by itself is nothing to shout about. Also, PFIN's debt/equity decreased from 49% last year to 34% this year. Despite a significant reduction in leverage, a debt/equity ratio of 34% is still considered high. By focusing only on improvement instead of absolute levels, firms with low profitability and high leverage can still get a perfect F-Score.

Secondly, the F-Score is not timely for contrarian value investing. If you wait for the robins, spring will be over. For many stocks especially the depressed cyclicals, the best time to enter into a position usually happens when the fundamentals of the companies are at their trough. The F-Score will pick up only these depressed stocks when there is an indication of improvement in financial metrics. By that time, the stock prices will have priced in the recovery, making valuations unattractive.

Lastly, the time frame for the F-Score is too narrow. The F-Score typically compares this year's financial metrics against those of last year and could create distortions in perception. For example, the F-Score requires a positive divergence between cash flow from operations and net income before extraordinary items. It will be a fairer assessment if the divergence between cash flow operations and net income is evaluated on a multi-year basis. Cash flow from operations could fall below net income in any single year as a result of the timing in recognition of net income.

Something does not have to be perfect to work.

As long as it is a strategy that makes sense and has been proven to work over a long time... If the principles are implemented through a disciplined strategy, it will give you an edge over time. It has been proven to work over the long term when you hold a diversified portfolio (30+) of these highly ranked stocks chosen within the lowest p/b ratios pool of stock (lowest 20% p/b).

That's why it is important to be well diversified. Quantitative screening won't just magically find the three best bargain stocks for you right now. It's just helping you find above average opportunities, on average. I would not give it too much weight to the F-Score alone unless it is implemented into a long term, diversified strategy with strict, unemotional buy sell decisions (1 yr holding period).

Excellent summary. Same conclusion I came to a few years ago during the height of the recession. Buffett warned investors to be cautious of people advocating formulas in determining if an investment is worthy. That's simply not what value investing is about.

Lastly, it's a silly notion to state one is best to be diversified in order to protect yourself in case a basket of F-Score stocks don't work out. That simply isn't rational thinking. It's far more rational to know what you're doing in a few stock selections than to rely on a formula based on someone else's work which very few have the mathematical knowledge to understand.

There are imperfections with any tool including P/S, P/E, EV/EBIT, etc. You must recognize that these are only screening tools that should not have too much importance attached to them. They must be looked at as a whole.

Interestingly, AAII shows the following results for the Piotroski screen:


Not too shabby

Not sure why the first column was deleted, however; in order they are YTD, 3 YR, 5 YR, 10 YR and since inception

There is nothing right or wrong with quantitative value investing per se. However, one should understand the reasoning behind the quantitative tools and formulas before using them. Quantitative tools can be a useful starting point, but not necessarily an end point.

The Piotroski score will give you a list of small cap stocks with very irratic histories and unpredictable futures. Using the Piotroski score as a "starting point for further research" is a total waste of time and effort. Fundamental analysis will be of no help and even the CEOs of these companies cannot predict their companies futures. These companies are unpredictable and thus are priced accordingly. Graham and Schloss used to buy low P/B and Net/Net stocks for years, usually holding over 100 at a time. they also did this with little fanfare and/or competition from other investors. That strategy no longer exists so Piotroski is the next best thing, for now until the whole world catches on. I wouldn't spend much time trying to "analyze" these companies. Just buy with lots of diversification (1% per stock) then monitor the stocks to ensure financials don't deteriorate (P-score stays at or above 8), which is another reason the AAII monthly screen works so well. I would sell upon a 50% gain like Schloss used to do. Once the whole world is using the Piotroski method then we can all go find something else that works since this will no longer work.