There has been a lot of buzz around Facebook (NASDAQ:FB) these past few months with some analysts encouraging you to buy and others cautioning you to sell or stay away. In order to get beneath all the mixed opinions, this article will take Piotroski’s approach, looking strictly at Facebook’s financials and giving the stock an F-score based on the nine criteria he identified.
There are four criteria used to determine how profitable a company is. Of these four criteria, Facebook satisfies three, making it appear to be a very profitable company. Those criteria are as follows:
- Return on Assets (ROA): This figure is essentially the company’s net income. In order to meet this criterion in Piotroski’s method, the ROA must be a positive number. With an ROA of 0.40, Facebook meets this requirement and receives a 1.
- Cash Flow from Operations (CFO): This tells investors how much the company is earning from its regular business activities (production, sales, etc). It must be a positive number in order to receive a score of 1. Facebook’s cash flow from operations was $1,612 meaning it definitely satisfies this requirement and receives a 1.
- Change in ROA: In order for the profitability of a company to be considered sustainable, it must show a steadily increasing return on its assets. To calculate this, we take Facebook’s current ROA of 0.40 and subtract the previous year’s ROA (15.80). This gives us a difference of -15.40, showing a decrease. Therefore, Facebook does not meet this requirement and receives a 0.
- Accrual: This criterion simply checks to make sure that the company’s cash flow from operations is higher than its return on assets. As we can see above, Facebook’s CFO of $1,612 is definitely greater than its ROA of 0.40 meaning that it receives a score of 1.
Financial Leverage and Liquidity
Piotroski uses three criteria to determine how stable a company’s finances are. These criteria weed out those companies with too many liabilities or other worrisome factors. Facebook satisfies two of the three criteria, telling us that it is relatively financially stable. The three criteria are:
- Change in Leverage: Every company is going to have debt and other liabilities. What is important then, is to identify those companies which are able to meet their debt obligations. To do this, Piotroski checks the company’s debt to equity ratio over the past few years to make sure that it is decreasing. Facebook’s current debt to equity ratio is 0.1215 which is a marked decrease from its previous ratio of 0.1269. Therefore it receives a score of 1.
- Change in Liquidity: This is another sign of a company’s ability to meet its debt obligations which shows us that it is a relatively stable and secure company. In order to meet this criterion, the company’s current ratio should be higher than it was in the previous year. Facebook’s current ratio is 10.71 which is more than double the previous year which was 5.12. So Facebook definitely satisfies this requirement and recieves a 1.
- Equity on Offer: A common sign of distress in a company is when it attempts to offer more and more shares. This could mean that it is unable to generate enough funds from its regular business operations. Therefore, to pass this criterion, a company’s outstanding shares should not be higher than in the previous year. Facebook’s current shares outstanding are at 2.455 billion whereas last year, they were at 2.166 billion. This represents a slight increase, meaning that Facebook receives a score of 0.
With this final category, Piotroski’s method is trying to gauge how well a company is operating. Maintaining high profitabilty and steady growth requires efficient operations. Unfortunately, Facebook does not meet either of the criteria in this section. The two criteria are:
- Change in Gross Margin Ratio: This represents a company’s profits relative to its costs. The gross margin should be increasing year over year in order to receive a postive score here. Facebook’s current gross margin ratio is 73% which is a decrease from the previous year which was 77%. Therefore, it receives a 0.
- Change in Turnover: High turnovers mean that a company has a strong ability to generate income. Therefore, its turnovers should be increasing year over year to indicate growth. Facebook’s turnover of 0.34 is down from the previous year (0.59). In this case, it receives another 0.
Based on these criteria, Facebook receives an F-Score of 5. This is certainly not as high as it could be. The ideal stocks to purchase have scores of 8 or 9. However, it is not necessarily a cause for concern. It still scored well on many key critieria. This F-Score simply means there will be some increased risk with investing in Facebook as opposed to other higher-scoring stocks.