Many of the famous screening methodologies that provide inspiration for this column hail from the US. When it comes to the ideas that underpin these screens there is normally, in my opinion, not much lost in translation as company fundamentals can be analysed on a fairly equal footing on both sides of the pond. But there are often problems relating to the scale - the US market is simply home to far more larger companies than can be found in the UK. This week’s screen is a case in point. I am running a screen devised by US accountancy professor Joseph Piotroski on the US market. Whereas the screen I ran in January for UK Piotroski stocks, which had a market cap cut off of just £10m, only yielded 12 results, my US screen based on the Russell 3000 constituents run this week has produced a portfolio of 33 stocks, the smallest of which has a market cap of $105m.
That said, big is not always beautiful. When I tallied up the performance of my six-stock 2013 UK Piotroski screen in January I found it had produced a stunning total return (share price movements with dividends reinvested) of 50 per cent over 12 months compared with 18 per cent from the FTSE All Share. While sentiment has changed quite a lot in the months that have since elapsed, particularly towards the kind of high-risk, deep-value, recovery plays Mr Piotroski devised his screen to find, it is nevertheless disappointing that last year’s US Piotroski portfolio of 16 stocks underperformed the market. While the 14.3 per cent total return the stocks delivered is not to be sniffed at, judged in absolute terms, it is disappointingly inferior to the 18.1 per cent achieved by the Russell 3000 (see table).
| Stock | TIDM | Total Return (14 May 2013 - 19 May 2014) |
|---|---|---|
| GENWORTH FINANCIAL CL.A | GNW | 64.7% |
| BRANDYWINE REAL.TST.SHBI NEW | BDN | 2.7% |
| CENTURYLINK | CTL | 7.7% |
| CARNIVAL | CCL | 14.8% |
| ROWAN COMPANIES CL.A | RDC | -12.4% |
| HANOVER INSURANCE GROUP | THG | 20.6% |
| FBL FINL.GROUP | FFG | 17.0% |
| ASPEN IN.HDG. | AHL | 20.5% |
| WINTHROP REALTY TRUST | FUR | 22.1% |
| CASH AM.INTL. | CSH | 0.0% |
| APCO OIL & GAS INTL. | APAGF | 28.7% |
| ICF INTERNATIONAL | ICFI | 34.9% |
| FUEL SYS.SOLUTIONS | FSYS | -35.2% |
| NAVIGATORS GP. | NAVG | 6.3% |
| EASTERN IN.HDG. - DELISTED 02/01/14 | - | 35.4% |
| BASSETT FRTR.INDS. | BSET | 1.1% |
| Average | - | 14.3% |
| RUSSELL 3000 | - | 18.1% |
Source: Datastream
But investors who use screens are meant to take the rough with the smooth. Conventional wisdom suggests that market beating returns through screening are only achieved over the long term by sticking doggedly to a chosen (and preferably proven) strategy. Indeed, the 2012 US Piotroski screen boasted a return of 62 per cent compared with 27 per cent from the market. Interestingly, investors who had stuck with that May 2012 portfolio rather than switching into the 2013 portfolio would now be sitting on a return of 111 per cent compared with the 83 per cent cumulative return achieved by switching (and that is before accounting for spreads or dealing costs). The Russell 3000 returned a superb 48 per cent over the same period.
Mr Piotroski’s screen is based on using historic fundamentals to predict whether cheap stocks, identified by low price-to-book ratios, are dogs or recovery plays. Deciding whether stocks are really cheap or cheap-for-a-reason is one of the hardest skills for value hunters. So the fact that he found his strategy produced 23 per cent annual returns between 1976 and 1996 on a long-short approach meant his 2000 paper “Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers” got considerable, and deserved, attention.
There are 9 fundamental tests that Mr Piotroski applies to “cheap” stocks (those with price-to-book-values among the lowest quarter of the market). The tests look at profits, cash flows and the balance sheet. What perhaps marks the method out most from other well-known screens that my column looks at is that there is a strong focus on looking at improving fundamentals rather than the actual level that fundamental ratios are at.
The current ratio test that Mr Piotroski applies is a good example of his screening style. The current ratio is a simple and somewhat crude way of measuring whether a company is well place to pay its upcoming bills. The ratio is calculated by simply dividing current assets (assets that should be fairly readily available to pay upcoming bills) by current liabilities (upcoming bills). The rule of thumb is that a current ratio of less than one is a worry and anything more than one is reassuring. Indeed, many popular screens, especially for value stocks which may be cheap due to financing difficulties, require the current ratio to be one or more. Mr Piotroski does not care what the current ratio actually stands at, but he does want to see it is moving in the right direction.
A further aspect of the ingenuity of his screen is that the various factors he tests for support often reinforce what he is looking to measure with other tests. So as well as wanting to see that the current ratio is moving in the right direction, he also wants an indicator that this is happening without the need for outside finances. Two further tests applied by Mr Piotroski therefore are that shares in issue have not risen in the past twelve months (ie no money is coming in from selling new shares to the public) and that gearing has fallen (ie new debts are not being taken on to pay upcoming bills).
Another difference between this screen and many of the other well-known screens this column looks at, is that, as an accountancy professor, Mr Piotroski has a keen focus on the underlying company rather than the company’s shares. Indeed, the only “per share” measure the screen bothers itself with is the initial assessment of value based on the price-to-book ratio. So the underlying philosophy of the screen seems to be that if corporate health is improving then the share price will follow (as long as it is not overvalued to begin with)
The full F-score criteria are as follows:
■ Positive profit after tax, excluding exceptional items. ■ Positive cash from operations. ■ Profits after tax excluding exceptional items are up on last year, which Professor Piotroski highlights as being of particular importance as a signal that a company may be in recovery mode and in the process of re-rating. ■ Cash from operations higher than profit after tax, excluding exceptional items, which indicates an ability to convert accounting profit into actual cash. ■ Gearing (net debt as a percentage of net assets) is down on the preceding year, which suggests that the company has not had to look for external sources of finance. ■ The current ratio (current assets divided by current liabilities) is up on the preceding year, which suggests that the company's ability to service upcoming financial obligations is improving. ■ No new shares issued over the last year, which again suggests that the company has not had to look for external sources of finance. ■ Gross margins have risen in the last year. ■ Improving capital turn (turnover as a proportion of net assets), which suggest greater productivity. |
Mr Piotroski considers a high F-Score to be 8 or 9 and I’m only interested in stocks that have achieved such a score. The screen’s focus on book value means it is prone to highlight certain kinds of companies that have more capital intensive operations and rely on assets to generate profits. I’ve taken a closer look at three of the larger stocks (fundamentals published separately in large table below) selected by the screen below and the rest are published in the table that follows
33 US Piotroski plays
