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Joseph Piotroski showed that if a majority of nine accounting variables for a company pointed in the right direction it indicates the company is not showing much sign of financial distress.
The nine metrics are usually applied to companies that have seen a decline in market value because of a period of poor trading – Mr Market is upset.
Piotroski’s work also shows that if these shares have a high score they generally outperform the market. The cause of this is likely to be an initial over-reaction by investors: companies having a hard time are seen as vulnerable to financial collapse. That may be true of many companies with declining profits or losses.
But those displaying recent decline together with a high Piotroski score are likely to survive if they are blessed with a good business (when analysed with a long-term perspective rather emphasizing short term troubles), and have decent managers – they recover more often than Mr Market assumes. Thus a portfolio of them outperforms.
(See Newsletter postings on 5th and 9th February 2015 for a discussion of Piotroski’s work).
I’ll apply the Piotroski factors to both the annual results (to February 2016) and the interims to August 2016.
Profitability factors
If the firm is profitable and produces positive cash flow it has a capacity to generate funds internally. A positive earnings trend suggests an improvement in the firm’s ability to generate positive future cash flows.
1.Positive net income before extraordinary items? Braemar (LSE:BMS) is currently profitable, even in the disappointing latest half-year. The January trading update expressed an expectation of profits for the full year to February 2017. So, a score of one is given.
2.Positive cash flow from operations? Yes, in both the annual report and the interims, so we can add another one to the score.
3.Improvement in return on assets employed in the business from the previous year? There has been a significant slide in profitability in both the year and the following six months. We score this factor at zero.
4.Is cash flow greater than profit (so profits are not driven primarily by positive accruals, which may be ‘managed’)? Braemar scores well on this, so……….To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
