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How to use the F-Score to help you find cheap stocks

by , 15 December 2014

Finding cheap stocks is one of the best ways of increasing your chances of making money when you invest.

But finding cheap stocks has its pitfalls. Some investment strategies can point you towards stocks that are financially unstable and not good investments.

So what can you do to find cheap stocks?

Read on to uncover an investment strategy to help you find cheap stocks…

What is the F-Score?

The F-Score is a way of measuring the financial strength of companies. Joseph Piotroski, an accounting professor at Chicago University, invented the test after a study he did in 2002 trying to find a way of identifying cheap stocks.

The first thing Professor Piotroski did was look at companies with low price to book ratios (P/B). He then devised nine tests to filter out companies that had poor finances, the one downfall of using the P/B ratio alone to find cheap stocks.

For each test a company passed, he awarded one point, Phil Oakley in Money Week explains. He then added these together to give the F-Score. High F-Scores (between seven and nine) pointed to companies that were showing sign of improving financial health.

How to use the F-Score

He found that by using his F-Score after finding stocks with low P/B ratios resulted in honing in on companies that would generate much better returns in the future than using the P/B ratio alone.

To find out how to calculate a company’s F-Score, go here.

Professor Piotroski’s analysis worked best with small and medium sized companies with low trading volumes that stock market analysts avoided.

His analysis showed that by focusing on companies with low P/B ratios and filtering these with his F-Score produced an extra 7.5% per year in returns than using low P/B ratios alone.

So there you have it, how to use the F-Score to help you find cheap stocks.

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How to use the F-Score to help you find cheap stocks
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