When it comes to investing, understanding the health or quality of a company is crucial. That's where financial ratios come in handy, and one particularly insightful metric is the Financial Strength Score (FS-Score).
This ratio is an enhanced version of the well-known Piotroski F-Score, and has been developed and tested by the great guys at Alpha Architect as described in the article Value Investing Research: Simple Methods to Improve the Piotroski F-Score.
It's designed to help you find stocks with strong financial health and operational efficiency.
This article tells you how FS-Score calculated, and how you can use it to make smarter investment decisions.
What does the ratio tell you?
The FS-Score is a comprehensive measure of 10 ratios that evaluates a company's financial stability and growth prospects.
It considers various aspects of a company's financial statements to assess its profitability, leverage and liquidity, and operational efficiency.
A high FS-Score indicates a company is financially healthy and could be a promising investment opportunity, while a low score may signal financial distress or poor operational performance.
How the FS-Score is calculated
The FS-Score is the sum of ten different binary signals, each reflecting a specific financial aspect of a company.
They are organised into three main areas:
- Current profitability,
- Stability, and
- Recent operational improvements.
Here's a breakdown of these signals and how they're calculated:
Current Profitability:
ROA (Return on Assets): If positive, scores 1; otherwise, 0.
FCFTA (Free Cash Flow to Total Assets): If positive, scores 1; otherwise, 0.
ACCRUAL: If Free Cash Flow is greater than ROA, scores 1; otherwise, 0.
Stability:
ΔLEVER (Change in Leverage): If leverage ratio decreases, scores 1; otherwise, 0.
ΔLIQUID (Change in Liquidity): If the liquidity ratio improves, scores 1; otherwise, 0.
NEQISS (Net Equity Issuance): If repurchases exceed equity issuance, scores 1; otherwise, 0.
Recent Operational Improvements:
ΔROA (Change in Return on Assets): If ROA increases, scores 1; otherwise, 0.
ΔFCFTA (Change in Free Cash Flow to Total Assets): If FCFTA increases, scores 1; otherwise, 0.
ΔMARGIN (Change in Gross Margin Ratio): If margins improve, scores 1; otherwise, 0.
ΔTURN (Change in Asset Turnover Ratio): If asset turnover improves, scores 1; otherwise, 0.
The FS-Score is then calculated by summing up the scores from these ten signals, resulting in a score between 0 and 10.
How you can use the ratio
Available as a screening ratio: Yes
Sort the column from high to low to identify companies with the highest FS-Scores.
Available as an output column ratio: Yes
To leverage the FS-Score effectively in your screener output, add it as a column under the "Quality" heading in your stock screener.
How to select the highest ratio companies:
To find companies with the highest or best FS-Score, adjust the slider from 0% to 10%. This filters out the top performers based on their FS-Score, making it easier for you to identify potential investment opportunities.
FS Score in the Company Dashboard
You can see the FS-Score as well as the value of all its components in the Company Dashboard under the Quality heading.
This is that it looks like:
F-S Score in the company dashboard
Reminder:
All ratios are calculated on a trailing 12 months (TTM) basis, ensuring you're working with the most current and relevant financial data.
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