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This is the most widely followed strategy on our site.

In the
Price-to-Book value strategy we showed how the trend in overseas markets for low price-to-book (PB) "value" stock portfolios to outperform high PB value portfolios was spectacularly confirmed on the JSE over the last 10 years. But running Decile-10 Price/Book portfolio requires guts. The portfolios are large (for the JSE, 10-20 shares) and with the cheapest on-line broker charging a minimum of R70.00 per trade, portfolio creation and re-balancing can become expensive.


Some shares in the portfolio can experience gut wrenching volatility as the investment community shuns them (only to later on realise they are undervalued) which can lead to some wild rides for the portfolio. You can view this for yourself by looking at the Price/Book model portfolio in the SCOREBOARD menu. Generally with these portfolios, you have 25% of the shares performing spectacularly, 35 % performing on-par with the market, 20% slightly under-performing and the rest performing dismally. However these portfolios do well due to the out-performance of the top 25% performers, which are usually quite spectacular.


This is because many low PB stocks are low for a reason and as the lowest PB stocks are generally distressed, not all of them manage to claw out of the hole they are in. Having said that, our previous Price/Book analysis on the JSE showed that very few low PB stocks (not more than 10%) "crashed and burned" and resulted in you losing money. Nevertheless, it would be nice to apply some sort of financial "evaluation" to low PB stocks to further screen out "weaker" issues and focus on those most likely to have strong financial fundamentals turn in their favour in the short to medium term, further accelerating their over-performance of the ALSI, and allowing us to get good performance by only having to manage smaller less risky portfolios.

One particular person came up with such a methodology that is quite successful. He is Joseph Piotroski and he is a professor at the University of Chicago. His paper, Value Investing: The Use of Historical Financial Information to Separate Winners from Losers, available as a PDF here, was published in 2000. In that paper, Piotroski showed that by using a set of nine different fundamental signals taken straight from the companies financials, to screen among low P/B stocks, an investor could separate the winners from the losers.

By buying only those stocks that had the highest scores, an investor could have outperformed the market by an average of 10% per year in the 20 year period running from 1976 to 1996. Piotroski started by screening for the stocks with the lowest P/B ratios that were non-negative. This limits the strategy to true value companies. After the price to book ratio, nine other pieces of information were used from the last two sets of financials as follows:

  1. Positive earnings
  2. Positive cash flow from operations
  3. Increasing Return on Assets (ROA)
  4. Quality of earnings : Operating cashflow > Net income
  5. Decreasing long-term debt as a proportion of total assets
  6. Increasing Current ratio (increasing ability to pay off short-term debts)
  7. Decreasing or stable number of shares outstanding
  8. Increasing Asset Turnover ratio, indicating increasing sales as a proportion of total assets
  9. increasing gross margins
Each company is given either a one or a zero on each variable to create an "F"-Score ranging from 0 to 9. The strategy calls for buying every company with the requisite low P/B ratio and a "F"-score of eight or nine. As Piotroski's research shows, low P/B stocks with high rankings are less likely to go bankrupt or to fall drastically in price than are those with low rankings, so this further adds to our defensive value picking investment strategy.

If you go to our Piotroski Backtests menu, we will show you how using this strategy in March 2002, in the trough of the last major market correction, would have picked you six shares that appreciated over 1,000% in the ensuing 5 year period. Similarly we have back tested this strategy on the JSE going back 14 years to 1995.

WHAT DO WE OFFER?

Our paid subscribers get access to a number of Piotroski services. We run a Piotroski blog that actively covers the events that occur during the running of our live Piotroski Model Portfolio. Here you can see new candidates and ejections from the portfolio as well as the makeup of the portfolio and performance over time. Every time a company releases a set of results we scan it for inclusion/exclusion to the portfolio. You can follow the blog to run your own portfolio or mirror the model portfolio.

The live model portfolio was incepted on 20th November 2008 and is actually performing quite well as can be seen below. It has a nice smooth progressive (not too steep) upward curve and is not subject to as much volatility as the JSE itself. It is managing to outperform the JSE by quite a margin so far in the 8 months it has been going.



Once a month we issue a Piotroski JSE Rankings report that lists all JSE shares together with their Piotroski sub-scores and F scores as well as other useful metrics. You can filter/pivot/sort by various of these metrics to research a suitable set of shares for your own portfolio. Many fund managers merely use this tool to guage a companies financial strength, regardless of book value. A snapshot is shown below:


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