One of the factors we use in the investment model to select companies for the Quant Value newsletter is the Piotroski F-Score
In September 2011 we completed a back test of the returns you could have achieved if you used a Piotroski F-Score strategy on European companies over the 12 years between June 1999 and June 2011.
A 525% return
As you can see in the chart below the results were impressive with the Piotroski F-Score returning 525% over the period compared to loss of 15% of the STOXX Europe 600 company index over the same period.
540% better than the index
That is 540% better than the index!
This is what the results of the back test looks like in a chart:
Theory behind Piotroski F-Score
Many investment research studies confirmed that buying a portfolio of low price-book value companies beat the market over time.
This makes sense
Intuitively this makes sense: you buy companies for less than what they’re worth in their books.
Experienced investors would argue that book value doesn’t always give a true picture of the companies’ value, and only a full review of the assets will help get a better understanding of the real value. While this criticism is correct they can’t deny the findings of these studies.
What if you could get rid of junk companies?
Joseph Piotroski (an accounting professor) had a closer look at the data and found that in a portfolio of lowest price-to-book companies, the profits were generated by only a few companies. In fact 44% of the low book value companies performed worse than the market.
So he thought to himself: wouldn’t it be great if we could filter out these companies?
Scoring system developed
Mr Piotroski wondered whether he could remove these rotten apples by looking at the companies’ books for the past two years.
He then developed a scoring system called the Piotroski F-Score, a 9 points scoring system based on profitability, funding and operational efficiency.
Looks at simple things
It looks at simple things such as: ‘has the company made more profit than the year before?’ (+1 point) but also: ‘is the company cooking the books by adjusting accruals?’ (0 points). By using 9 points he was able to get enough signals to determine whether the company is really improving or not.
The simple score works
What he found in his research is that this score helped to predict the performance of these low price to book value companies. This was more successful when applied to small and medium sized companies.
Tested it for Europe
As most of the research, including that of Mr Piotroski, was done on companies in the USA we wanted to see if it also works for European companies.
And as you saw in the above example it clearly does.
Part of the model that selects investments for you
This has led us to of course incorporate the Piotroski F-Score as one of the factors we consider to select companies for the investment ideas you receive in the Quant Value newsletter.
Through further testing we have found other factors, when combined with the Piotroski F-Score that can give you even higher returns.
Find out more in the investment paper
We have of course also combined these factors in the newsletter’s investment model. You can read more about these factors in the investment research paper you receive as soon as you have subscribed.