How to Improve The Piotroski Score To Achieve 26% Annual Gains

We improve the Piotroski F Score with the addition of one very simple factor that propels this strategy to return 26% a year.

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Written by Liam Flavelle on 2 August 2018

  • I published an article last month showing a backtest with 20% returns from a simple Piotroski F-Score strategy
  • The addition of one simple factor dramatically increases the score's performance
  • This factor adds the timing element that the original strategy was missing.

The Piotroski F-Score is a number between 0-9 that uses nine criteria to determine the strength or weakness of a company's financial position. Named after its inventor, Joseph Piotroski, the score tries to differentiate quality stocks that are likely to show price appreciation when compared to their lesser quality peers.

My article from last week (here) shows that selecting on a monthly basis the top 10 US stocks with the highest Piotroski Score would have returned 20% a year since 2000 and proved that the score, even though it has been public knowledge for the past 16 years, still gives you a winning formula when it comes to picking quality stocks. What I and other commentators felt was missing from the strategy was a timing element that told us when would be a good time buy a stock.

Price to Free Cash Flow

The revised strategy is almost identical to last week's one - investing $10,000 and once a month buying the top 10 US shares and depository receipts with a market cap of at least $50m and a Piotroski score of 8 or 9, ranked by the Piotroski F Score itself. My issue with it was the reliance on just one factor on which to base its investment decisions, with no logic to deal with the ties occurring in the ranking at each rebalance.

Step forward the Price to Free Cash Flow ratio, which when added to the strategy improves its returns since 2000 to 26% a year:

Click image to view the strategy

Looking at the annual performance tells us that this is a more volatile strategy as both gains and losses have increased and 2011 now shows as a loss:

Original
New

The Market Cap chart may explain some of the differences in performance - the new strategy has shifted its focus slightly to smaller companies. You often get improved returns when moving down the food chain and opening positions in companies with smaller market caps, but you typically get increased volatility as a result.

Original
New

Conclusion

A good strategy is made up of two sets of rules - one set to tell us why we should be buying a company and the other to tell us when we should be buying it. I've improved my original strategy by adding price to free cash flow that acts as a timing factor and increases theoretical returns to 26% per year over the test period.

Thanks to all those who suggested improvements over the various forums the original article went out to - keep the ideas coming!

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