The Piotroski F-Score

Buying statistically cheap stocks (low price-to-book, for instance) works on average over long periods, but the "value" bucket includes both genuinely undervalued companies and companies that are cheap because they are quietly falling apart — value traps that keep getting cheaper as the business deteriorates. Joseph Piotroski built the F-score to separate the two using only information already in the financial statements: nine binary tests across three categories — profitability (is net income positive, is operating cash flow positive, are both improving year over year, does cash flow exceed net income), leverage and liquidity (is leverage falling, is the current ratio improving, were no new shares issued), and operating efficiency (are gross margin and asset turnover improving) — each scored 1 point if passed, 0 if not, for a total from 0 to 9.

The strategy is simple to apply: restrict to the cheapest quintile of stocks by book-to-market, then within that group favor high F-score (typically 8–9) names and avoid low F-score (0–1) names, since a high score signals a company's fundamentals are genuinely improving rather than merely being priced for distress.

A cheap stock scoring 8 out of 9 — profitable, cash-generative, deleveraging, no dilution, and improving margins — looks like a company the market hasn't yet recognized is recovering; the same cheap price on a stock scoring 2 out of 9 more likely reflects a business that is correctly priced for continued decline.