Mixed returns from Piotroski F-Score shares

Those tests - which are detailed in full below - combine to give a share's F-Score. Backdated between 1976 and 1996, and filtered again for equities with low price-to-book value ratios (P/BV), Mr Piotroski found that a long-short strategy on the stocks with the highest and lowest F-scores led to a 23 per cent annual return. Our own version of the screen, applied to stocks across the FTSE All-Share, FTSE Small Cap and Aim indices, failed to deliver anything like those kind of profits over the past year. In fact, a weighted average of the 53 stocks thrown up by the screen provided a negative return of 0.25 per cent even with dividends reinvested.

When we first ran this screen in 2014, we were concerned that applying a low P/BV filter to high F-Score stocks would lead to a concentration of companies with large asset bases, which is often a sign of capital-intensive businesses. To remedy this, our picks combine high F-Scores - defined by Mr Piotroski as eight or above - with cheap ratings on at least one of five classic valuation metrics: P/BV, dividend yield (DY), enterprise-value-to-sales (EV/S), enterprise-value-to-free-cash-flow (EV/FCF) and a dividend- and cash-adjusted price/earnings growth ratio (GV, or genuine value). The one silver lining to this year's stock screen is that the decision to broaden the definition of value improved the performance. Had we concentrated purely on stocks with a low P/BV, as Mr Piotroski does, the F-Score value screen would have produced an even more dismal negative return of 2 per cent.

F-Score value performance 25 August 2015 - 28 July 2016

Source: Thomson Datastream

One of the interesting features of the stocks selected by last year's screen was that limiting the bias to small-caps did not work. In fact, the relative performance of the FTSE All-Share picks against the profitable FTSE Small Cap and Aim stock selections was stark. The 27 F-Score All-Share stocks, which included a heavier weighting to blue-chips, delivered a negative return of 13 per cent and underperformed the benchmark by 26 per cent. In total, 18 of the shares lost value, and all but five beat the FTSE All-Share's return over the period. This represents something of a reversal of the 2014 All-Share screen, which generated a 22 per cent return against a meagre 1.3 per cent boost in the benchmark.

Meanwhile, the smaller selection of FTSE Small Cap and Aim stocks picked up by last year's screen comfortably beat their respective markets. Although valuations tend to be most extreme among small-caps, the F-score value stocks identified on Aim have done particularly well on the basis of two years' evidence. This year, selections from the junior market booked a return of 14 per cent, beating last year's 13 per cent gain, and putting the F-Score Aim screen out in front on a cumulative basis since 2014. So while an equal-weighted average of the F-score stocks is ahead of the FTSE All-Share, the premium has come from Aim stocks.

F-Score equal weighted stock average

F-Score Value vs FTSE All-Share 2014-16

At least in theory, this means we should expect good things from this year's screen, whose 38 stocks provide a greater weighting to Aim than previous years (see tables below). It's somewhat surprising that the screen hasn't generated more ideas from the junior market in the past, given Aim's higher exposure to companies in rapid growth mode. That's because Mr Piotroski's F-score emphasises the importance of improving earnings and an improving current ratio, regardless of current levels. However, the screen's requirement for free cash flow, post-tax earnings and an absence of external financing ends up excluding many Aim constituents.

Following a reader request, we have also included each company's F score in this year's table, while the final column indicates whether the stock passes the five value measures (P/BV, DY, EV/S, EV/FCF and GV). To do this, the stock must be among the cheapest quartile of its peer group.

FTSE All-Share

Source: S&P Capital IQ

FTSE All Small

Source: S&P Capital IQ

FTSE Aim All-Share

Source: S&P Capital IQ

F-Score tests:

■ Positive profit after tax, excluding exceptional items.

■ Positive cash from operations.

■ Profits after tax excluding exceptional items are up on the prvious 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 past year.

■ Improving capital turn (turnover as a proportion of net assets), which suggest greater productivity.