Does It Work: Piotroski's F Score in Indian Equity Market in 2021?
In 2000, a young Joseph D. Piotroski at the University of Chicago Graduate School of Business published a paper titled “Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers”. The paper attracted a lot of attention in the financial world as it claimed that investors can potentially make handsome returns with companies having a high book-to-market ratio.
Piotroski had identified 9 distinct elements for his analysis to identify financially strong and distressed firms in the market. Companies with strong financial fundamentals would get a score of around 4-5 and companies with weak financial fundamentals would have a low F score.He considered the following financial points:
- Return on assets (ROA)
- Cash flow from operations
- Change in ROA
- Change in Accruals
- Change in leverage
- Change in liquidity
- Change in equity
- Change in margin
- Change in asset turnover
How to use the variables to generate an F score for a company
Formula to calculate F score
Now since we have a decent understanding of the F-score, let's see how it performs in the Indian equity market.
I came across a research paper which attempted to do the same and this blog is a simpler explanation of the same. The research paper aimed to see if the F Score when applied to high book-to-market firms can essentially move the current and future stock performance in favor of the investor or not.
The study concluded that an F score when used for companies having a high book-to-market value and a high F score can shift the distribution of the returns in the Indian equity market. The researchers found the impact of the F scores on the future stock valuation to be statistically significant with a 5% level of significance. Also, there exists a positive relationship between a high F score and future stock performance with 10% statistical significance.
This could be due to the fact that companies with high book-to-market value are considered fundamentally cheap or underrated and thus investing in them could bring more returns to the investors as they hold a strong potential to go big in the future.
However, one should also pay attention to the fact that just using an F score for making his investment might not give him a true picture of the stocks. It could be the company having a high book-to-market value may not be ill-priced and thus investing in them may not bring the expected returns.
Another reason for not completely relying on the F score is that it focuses on the current performance of the company and thus the impact of the F score may be skewed.
Also, it will be too quick to jump to a conclusion since a lot of studies have not been done in the Indian market to gauge the impact of the F score in the equity market.
So does the F score work in the Indian equity market. Well, I leave that up to you to explore.