Explained: What Is Piotroski's Method Of Finding Good Stock?

The Piotroski method analyzes stock fundamentals using the Piotroski Score, a metric developed by accounting professor Joseph Piotroski. It helps value investors identify potentially undervalued stocks with strong financial health. The score ranges from 0 to 9, with higher scores indicating better financial performance. If the score is between 4 to 6, it is an average investment and requires deep study before investing. A score between 7 to 9 is highly recommended by experts. The score is based on nine binary criteria related to profitability, leverage, liquidity, and operating efficiency. If each criterion is met, it contributes one point, resulting in a maximum score of 9. Reliance Industries and HDFC Bank have a Piotroski score of 6 and 5, respectively.  

So today, let's analyse the stock Rail Vikas Nigam, based on Piotroski's score. The stock is down 10.60 per cent in one month. You will need the following financial data from Rail Vikas Nigam's income statement, balance sheet, and cash flow statement for both the current year (2024) and the previous year (2023). The factors are net income, return on assets (ROA), operating cash flow, total assets, current assets and current liabilities, long-term debt, Outstanding shares, gross margin, and sales or revenue.

Profitability Criteria

1. Net income: The Net Income of the current year should be higher than the net income of last year, and your stock gets one point. Rail Vikas Nigam's Net profit in March 2024 and its trailing 12-month profit are higher than those of March 2023.

2. ROA: RVL Nigam's ROA is 8.06 per cent. If a stock's ROA is positive, it gets 1 point in the Piotroski method. Each criterion earns the stock only 1 point, regardless of performance. For instance, even if ROA is 20 or even if ROA is 1, the stock will only get one point for ROA. This levels the competition between stocks and accommodates capital-intensive stocks with lower ROA.

3. Change in ROA: If the ROA of an asset has increased compared to the previous year, the stock gets one point. RVL's ROA has increased by 17.18 per cent compared to the previous year, so it earns one more point.

4. Cash Flow from Operations: RVL's cash flow from core operations was Rs 2,939 crore last year compared to Rs (-4,028) from the previous year. If the operating cash flow increases compared to that of last year, the stock gets one more point.

Financial Strength

The financial strength of a company is analysed through leverage and liquidity ratios.

5. Change in Leverage: The long-term debt has decreased from Rs 6,031 to Rs 5,516 bringing and Assets are maintained at the same level. So the leverage ratio comes down. When the leverage ratio comes down YOY, the stock earns one point.

6. Change in Current Ratio: The current ratio also came down in March 2024 compared to March 2023, so RVL is better positioned to handle its short-term liabilities and working capital needs, which gets it one more point.

7. No New Shares: A stock that has not issued new shares in the last year receives one point because it indicates a lack of dilution. RVL issued zero new shares last year - 1 point.

Operating Efficiency

8. Change in Gross Margin: Gross Margin is calculated as  Gross Profit divided by Total Revenue. As the gross margin has increased YOY, the RVN Ltd scores one point.

9. Change in Asset Turnover: The percentage up to March 2024 is 1.20 per cent, which is higher than the previous year's percentage of 1.11 per cent. So one more point. Asset Turnover is determined by dividing the Total revenue by Total Assets.

Total Piotroski Score for Rail Vikas Nigam is 9 points. Several websites are available on the Internet that provide the Piotroski score when you enter the stock's name.

Is Piotroski method Foolproof?

No. Because it only studies the above-mentioned nine factors, which only form a small fraction of ratios and indicators in fundamental analysis. But the Piotroski method saves time as fundamental analysis of stocks usually takes much time. But using Piotroski you can save time studying only limited factors as Piotroski stresses the Pareto Principle, also known as the 80/20 Rule, which posits that a large portion of results or outcomes (approximately 80 per cent) comes from a relatively small number of causes or inputs (about 20 per cent).

It's not advisable to rely solely on the Piotroski score for stock investing. This is because the Piotroski score is only based on analysis of stock fundamentals. Stock analysts use both technical and fundamental analysis to determine whether to invest in a stock. Technical analysis posits that the price action of a stock is also an important factor, and if you invest in a stock when it is in a seasonal down curve, you may get stuck with that investment for many years. Nevertheless, as long as fundamentals hold firm, the stock will likely recover. So analyse the stock's price action and invest based on your investment goals and tenure.