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Summary The Piotroski F-Score was designed to find companies that are cheap and recovering. The first year showed mixed results. This year the portfolio has been adjusted in an attempt to improve performance. This is the first article of the second series of articles looking at the investment performance of the Piotroski F-Score. In the first series, I covered the performance of a Piotroski F-Score long only strategy over the space of twelve months. The results were extremely disappointing. The value of the portfolio declined by 49.3% over the period . Still, giving up on the strategy after only one year wouldn’t accomplish much. So, this year two of the study. The details of the study are below. Finding value In the world of value investing, there are many ways to hunt for value opportunities. However, few are as well defined as the Piotroski F-Score, which aims to identify the healthiest companies amongst a basket of value stocks through applying a set of nine accounting-based stock selection criteria. The F-Score was designed to hunt out value opportunities that are profit-making, have improving margins, don’t employ any accounting tricks and have strengthening balance sheets. However, as usual, this strategy cannot be employed alone, it needs to be combined with another screening tool to produce a suitable set of results. One point is awarded for each criterion the company passes and the stocks that score the highest, eight, or nine are regarded as being the strongest candidates for recovery. Piotroski recommended scoring the bottom 20% of the market in terms of price to book value and then working from there. Using the following system, Piotroski’s April 2000 paper Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers , demonstrated that the Piotroski score method would have seen a 23% annual return between 1976 and 1996 if the expected winners were bought and expected losers shorted. According to the American Association of Individual Investors , year to date the F-score screening criteria with a low P/B value would have returned 3.4%. Over the past five years this return would have been 33.9% and the ten-year return was 26.7%. The screen I’m testing the F-Score, as both a way to discover value stocks and trade them without fundamental analysis. The screening criteria and investments are based purely on the financials in an attempt to remove any emotional bias — something that holds back investment performance. The F-Score screening criteria are as follows: Profitability Signals 1. Net Income – Score 1 if there is positive net income in the current year. 2. Operating Cash Flow – Score 1 if there is positive cashflow from operations in the current year. 3. Return on Assets – Score 1 if the ROA is higher in the current period compared to the previous year. 4. Quality of Earnings – Score 1 if the cash flow from operations exceeds net income before extraordinary items. Leverage, Liquidity and Source of Funds 5. Decrease in Leverage – Score 1 if there is a lower ratio of long term debt to in the current period compared value in the previous year. 6. Increase in Liquidity – Score 1 if there is a higher current ratio this year compared to the previous year. 7. Absence of Dilution – Score 1 if the Firm did not issue new shares/equity in the preceding year. Operating Efficiency 8. Gross Margin – Score 1 if there is a higher gross margin compared to the previous year. 9. Asset Turnover – Score 1 if there is a higher asset turnover ratio year on year (as a measure of productivity). And the 20 largest companies that qualify in the current environment are as follows (in order of mkt. cap): NRG Energy Inc (NYSE: NRG ), Noble Corp plc (NYSE: NE ), Darling Ingredients Inc (NYSE: DAR ), EP Energy Corp (NYSE: EPE ), DigitalGlobe Inc (NYSE: DGI ), McDermott International (NYSE: MDR ), Atwood Oceanics, Inc. (NYSE: ATW ), Cash America International Inc (NYSE: CSH ), Navigator Holdings Ltd (NYSE: NVGS ), Danaos Corporation (NYSE: DAC ), DHT Holdings Inc (NYSE: DHT ), Roadrunner Transportation Systems Inc (NYSE: RRTS ), Century Aluminum Co (NASDAQ: CENX ), Ocean Rig UDW Inc (NASDAQ: ORIG ), West Marine, Inc. (NASDAQ: WMAR ), Marchex, Inc. (NASDAQ: MCHX ), Luby’s, Inc. (NYSE: LUB ), Manning and Napier Inc (NYSE: MN ), Hardinge Inc. (NASDAQ: HDNG ), Trans World Entertainment Corporation (NASDAQ: TWMC ). P/B figures rounded to the nearest whole number. To assess the F-Score, I’m starting a hypothetical portfolio with a $1,000 investment in each company. Investment prices are based on the closing price on 11/20/2015. These positions are based on financial data only; there’s no weighting to fundamental factors. I’ve decided to use this method in an attempt to take all of the emotion out of the trading and running of the portfolio, only when a stock qualifies under the set criteria will it be included in the portfolio and held for the next 12 months until rebalancing. Like the original Piotroski F-Score, as well as buying a basket of stocks that qualify for the screen, I’m also shorting a hypothetical basket of stocks. The short basket will be composed of companies that have the lowest F-Score in my screen. For liquidity issues, I’m excluding any companies with a market cap. of less than $100m from my short basket. Here are the short candidates, in order of market cap: Vertex Pharmaceuticals Incorporated (NASDAQ: VRTX ), Tesla Motors Inc (NASDAQ: TSLA ), Under Armour Inc (NYSE: UA ), Ctrip.com International, Ltd. (ADR) (NASDAQ: CTRP ), BioMarin Pharmaceutical Inc. (NASDAQ: BMRN ), Endo International plc (NASDAQ: ENDP ), Annaly Capital Management, Inc. (NYSE: NLY ), OneMain Holdings Inc (NYSE: LEAF ), Seattle Genetics, Inc. (NASDAQ: SGEN ), STERIS Corp (NYSE: STE ), Renren Inc (NYSE: RENN ), Southwestern Energy Company (NYSE: SWN ), Impax Laboratories Inc (NASDAQ: IPXL ), bluebird bio Inc (NASDAQ: BLUE ), The Medicines Company (NASDAQ: MDCO ), SolarCity Corp (NASDAQ: SCTY ), HRG Group Inc (NYSE: HRG ), Federal National Mortgage Assctn Fnni Me ( OTCQB:FNMA ), Prothena Corporation PLC (NASDAQ: PRTA ), Nord Anglia Education Inc (NYSE: NORD ). The short portfolio is being run with the same rules as the long portfolio. The companies have been selected based on financial data only; there’s no weighting to fundamental factors. Stocks will be included in the portfolio and held for the next 12 months until rebalancing. To reiterate, there’s no bias here. The companies selected are only included because they have the lowest F-Score of the largest 11,300 US companies my screen covers. The number of shares sold short will have an initial value of $1,000. Putting it altogether Here are the two initial portfolios based on the closing prices as of 11/20/2015. The bottom line Those are the 40 picks. I will admit that some of the companies mentioned above are risky bets but on a purely financial basis, they conform to the F-Score criteria, so they have been included. I’m tempted to include some fundamental analysis for each company, but that’s not the point of this study. Research has shown that emotional bias is one of the investors’ worst enemies; the F-Score tries to eliminate that That’s the introduction, over the next few months I will be assessing the portfolio’s performance on a regular basis with a final round-up this time next year. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Scalper1 News
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