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Ten new Piotroski picks for 2016

Our backwards-looking Piotroski screen had a disastrous 2015, but longer-term returns still look impressive
January 26, 2016

A number of screens I use have had an incredibly good run over recent years, which means this week's screen can be seen as offering a reminder that no one should ever be complacent about the ability of screens to produce outperformance. Indeed, last year's Piotroski screen has performed terribly (although not quite as badly as the Greenblatt Magic Formula screen, which I'll be raking over in two weeks' time).

The screen, which was developed by American accountancy professor Joseph Piotroski, focuses on companies with low price-to-book ratios that appear to be experiencing an improvement in their fortunes. Unfortunately, over the past two years the screen has been more prone to finding shares that are priced for trouble rather than those priced for recovery. The past 12 months were particularly dire, with the 12 Piotroski shares selected at the start of 2015 producing a negative total return of 20.9 per cent, compared with 8.7 per cent from the FTSE All-Share.

 

2015 performance

NameTIDMTotal return (19 Jan 2015 - 20 Jan 2016)
VianetVNET33%
RotalaROL27%
Bovis HomesBVS15%
Peel HotelsPHO14%
CrestonCRE0.1%
Great Portland EstatesGPOR-1.7%
Raven RussiaRUS-13%
Anglo-Eastern PlantationsAEP-14%
HuntingHTG-47%
EvrazEVR-61%
Volga GasVGAS-64%
International Ferro MetalsIFL-70%
Rambler Metals and MiningRMM-88%
Average--21%
FTSE ALL SHARE - TOT RETURN IND--8.7%

Source: Thomson Datastream

 

The problem with looking for cheap shares is that they are often cheap for a reason. And the problem of using past performance to judge the reasons for a share's cheapness, which is what the Piotroski screen does, is that the past will not alert investors to major changes in a company's prospects, especially if the change is wrought by external events. Indeed, often shares are cheap in anticipation of trouble to come, rather than as a reflection of past troubles. The Piotroski screen's focus on the past was a key reason for the dire performance last year. These risks were evident in last year's screen results at the time and, indeed, I felt the need to highlight the potential for disappointment.

 

Comments from my 2015 Piotroski column:

"Risks are abundant in this year's share picks as the screen is very keen on shares with exposure to two major areas of uncertainty - commodity prices (five out of 12 shares) and Russia (three shares out of the 12, two of which are also resources companies).

… It's worth noting that all the [Piotroski] tests focus on historical data. That means the screen cannot account for the impact of things such as sanctions against Russia or a large drop in commodity prices on future reported earnings. This could prove a major weakness for the Piotroski screen if these themes continue to weigh on sentiment given that almost half the 2015 picks have exposure."

 

That said, the screen's contrarian approach can be regarded as a key reason for much of the performance the Piotroski screen has shown itself capable of generating over the long term (in the 20 years that were tested by Mr Piotroski up to 1996, he found a long-short approach based on his criteria achieved an average annual return of 23 per cent, almost double that achieved by the S&P 500). After all, had the commodity cycle turned back up last year (with hindsight this feels a laughable proposition, but it was not an entirely ludicrous thought 12 months ago), the 2015 screen could be basking in all kinds of glory. What's more, the screen is still showing some outperformance over the four years I've run it. The total return over that period stands at 33.5 per cent, compared with 21.2 per cent from the FTSE All-Share. Meanwhile, if a 2 per cent annual charge is factored in to account for costs, including the wide spreads on the small-caps included in the screen results, the total return still stands just above the index at 23.1 per cent, even after the ghastly 2015.

 

Piotroski vs FTSE All-Share

Source: Thomson Datastream

 

The screening system developed by accountancy professor Joseph Piotroski looks at nine interrelated factors that measure signs of positive progress from a company's recent income statements, balance sheets and cash flows. The screen works on the principle that with really bombed-out shares, the market is very slow to factor in improvements in trading, so historic data can prove especially valuable when hunting for turnaround situations. However, as last year's screen result also demonstrates, relying on the rear-view mirror means dangers in the road ahead can be missed.

 

The F-score criteria:

■ 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 is 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 past 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 sought to identify bombed-out shares based on low (bottom quarter) price-to-book values (P/BV). Using P/BV as a measure of cheapness does skew the screen towards specific types of 'value' situations; namely companies that trade off a large asset base such as property companies or companies in capital-intensive industries. An alternative version of this screen, which looks at a wider selection of value measures, has done well so far in the two years that I've run it.

The screen is interested in cheap shares in companies with a 'high' F-score, which is defined as eight or more out of the nine. I've screened the FTSE 350, All Small and Aim separately to try to get around the screen's bias towards smaller companies. Ten stocks passed the screen's tests and I've provided short write-ups below of the four stocks that have a maximum F-score of nine.