Friday, February 09, 2007


Want to earn a free buck? How do Wall Street analysts justify their rock-star lifestyles? By taking their job seriously. They take the time to learn about obscure advances in finance and use quantitative tools discovered by PhD students from around the country to outsmart the average Main Street investor. One such tool is the "F-Score." A quick background and summary:
  • For years, smart people (Fama, French, et al) have known that companies with low market to book ratios outperform companies with high market to book ratios. This in itself is no doubt a tool that traders look for on their Bloomberg screens.
  • Among low M/B (or B/M) stocks, Joseph Piotroski sought to discover some characteristics that separate the winners from the losers. I'm guessing he ran a whopper of a regression with dozens/hundreds of lagging ratios and indicators against prospective stock returns.
  • In the end, he came up with the insanely simple F-Score model that Wall Street uses (among many other models) to help allocate their portfolios.
And here it is:
Look at the most current financial statements for a company. Ask yourself the 9 questions listed below. If the answer is "yes" enter a 1, "no" enter a 0:
  1. Is net income positive?
  2. Is operating cash flow positive?
  3. Is operating cash flow > net income?
  4. Has return on assets increased (from the prior year)?
  5. Has gross margin improved?
  6. Has asset turnover improved?
  7. Has LT Debt / Total Assets decreased?
  8. Has the current ratio improved?
  9. Has there been no new equity issuance?
Sum up the numbers. Buy and hold companies with a score of 8 or 9, and short stocks with F-Score of 0 or 1.

1 comment:

Living Off Dividends & Passive Income said...

great summation of f-score!