How To Improve Your Results With The F-Score
Back in 2000, an associate professor at the University of Chicago, Joseph Piotroski, wrote a paper titled Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers.
Piotroski developed a system of ranking stocks based on nine items from the financial statements that has become a powerful tool for value investors. Mr. Piotroksi found that by tracking changes in the financial combined with price to book value investors could outperform the stock market by a wide margin. In his recent paper” The Quality Dimension of Value Professor Robert Novy Marx's work showed that this strategy has performed very well between 1963 and the end of 2012 with substantial outperformance over the indexes.
The system ranks 9 variables and each positive comparison scores a point on what is now called the F-score scale. The higher the stocks ranking the better the shares should perform over the next few years. Stocks that score below five should be avoided or considered as short sale candidates. It is a pretty simple system and there are several screeners that allow you to quickly and easily find stocks that trade below book value and have high Piotroski scores. In spite of its successful results and relative ease of use it is not widely followed outside the value investing community.
When you run the screen today some very interesting companies show up as buy candidates, particularly outside the United States. Aeon Ltd (OTC: AONNY) is a Japanese retailer that operates stores in the general merchandise, supermarket, discount, drugstore and several other classifications. Although not well known in the US this is a huge company that owns malls, provides credit services that operates in japan and 13 other Asian nations.
The firm has over 16,000 stores and branches and more than 250 different operating companies. The company earns an F-score of eight and trades for just 80 percent of tangible book value. As the Japanese economic situation improves this stock should be a top performer and recover much of the ground lost since the global economy topped out in 2006.
A little closer to home is Canadian oil and gas exploration and production company Penn West Petroleum (NYSE: PWE). Most of the company's assets and proven reserves are in Western Canada. The company has almost six million acres of land available for their activities and have been focusing on improving their capital allocation in the past year. Conditions have been improving and this is reflected in their F-score of six. The stock trades at around 80 percent of book value and also yields 4.8 percent at the current price.
Israel based Optibase (NASDAQ: OBAS) used to be in the video business until it sold those operations back in 2010. Today, the company owns real estate in Switzerland and Miami Florida and is looking for other income producing real estate opportunities around the world. The Swiss properties are commercial real estate while Miami holdings consist of residential condominiums.
The company also has minority interests in office properties in Philadelphia and a shopping center in San Antonio. The company earns and F-score of eight and the shares fetch just 50 percent of book value at the current price.
One US company that makes the grade is Century Aluminum (NASDAQ: CENX). Century sells aluminum products in the United States as well as Iceland. The company has been working to reduce its operating costs and recently negotiated a new power contract that should help further improve its cost structure.
Aluminum demand and pricing has been very weak for the past few years but is slowly starting to improve as there are signs of increased global economic activity. Century is seeing improving fundamental conditions and earns and F-score of six. The stock trades at just 80 percent of tangible book value at the current quote.
Using F-scores to select those book value bargain stocks with the most potential has proven to be very effective both in the classroom and in the markets.
Using this relatively simple but effective tool can help long term investors that may be value traps that may be cheap but have deteriorating business conditions that could lead to continued losses and lower stock prices. Tracking F-scores should be part of the regular research process for most investors, especially those drawn to an asset based value approach.
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