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Does the F-score improve the performance of different value investment strategies in Europe?

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Abstract

This study examines whether the performance of different value investment strategies can be improved with Piotroski’s (J Account Res 38:1–41, 2000) F-score screening method for the European stock markets. Our aim is to investigate the ability of the screening method to distinguish between winners and losers among several value investment strategies that use different financial ratios to form portfolios, such as B/M, E/M, D/M, and EBITDA/EV ratios. The results of the study provide compelling evidence that the F-score screening method significantly improves the performance of all investigated investment strategies. The results regarding the superior performance of the high F-score portfolios are robust across investment strategies, various performance measures and risk-adjustment methods. The results are useful for individual investors and professional portfolio managers.

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Notes

  1. These studies broadly indicate that high B/M companies tend to be less profitable, more leveraged, have more distress risk, respond more negatively to economic shocks and carry a greater probability of default. Because of the greater risks, these stocks should be priced with a higher risk premium.

  2. This strand of literature broadly suggests that investors are overly pessimistic (optimistic) about the companies that have done poorly (well) in the past, which causes value (glamor) investments to be undervalued (overvalued). Much of this type of mispricing is related to earnings announcement periods and mispricing is especially strong among small companies with low analyst coverage.

  3. Similar to these studies, Fama and French (2006) show that F-score is a leading indicator of future profitability implying that it is a good proxy for the strength of companies’ fundamentals, while Broussard et al. (2016) show that the F-score is useful in differentiating which companies migrate from value portfolios to neutral or growth portfolios and therefore also serves to explain the returns of different investment styles. Finally, Turtle and Wang (2017) show that the F-score can be used to improve the performance of momentum strategies, while Novy-Marx (2014) uses F-score as a stand-alone criterion to screen stocks and finds that the F-score screening method, without sorting stocks first based on B/M ratio, offers one of the best performance among several quality investment strategies investigated in the study.

  4. For example, while individual investors rarely take short positions, many institutional investors are simply not allowed to take short positions. For references and for more detailed discussion of the literature, please see Stambaugh et al. (2012).

  5. According to Novy-Marx (2014), the strategy selects stocks that are of high quality (i.e., high profitability), while value strategies tend to select stocks that are of low quality (e.g., low profitability, high debt).

  6. It is acknowledged that Datastream may have problems with the small stock market data. Following Ince and Porter (2006), we manually screened our data sample to ensure that there were no unusually high monthly returns or dividend yields.

  7. Given that the main purpose of the study is to investigate whether the Piotroski screening method improves the performance of various value investment strategies, the potential underestimation of the performance of the market portfolio prior to 2001 should not affect the main conclusions of the paper.

  8. This approach could potentially cause some bias in our results. However, according to Beaver et al. (2007), this has the most significant impact on the returns of growth stocks, which are not examined in the study.

  9. The factors for the European financial markets are publicly available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.

  10. Overall, the results discussed in “Returns of the portfolios” section remain qualitatively the same in the face of alternative screening approaches, where high (low) F-score portfolios consist of stocks that receive a score between 8 and 9 (1 and 2) at the time of portfolio formation. In our further robustness analysis we show that the results regarding the outperformance of high F-score portfolios over other portfolios also remain the same in different market states, i.e., bull and bear markets as defined by Lunde and Timmermann (2004). For the sake of brevity, we do not report these results but they are available from the authors on request.

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Acknowledgements

The paper received the Ben Graham Center for value investing award at the 25th Multinational Finance Society conference in Budapest, 2018.

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Authors and Affiliations

  1. OP Wealth Management, Helsinki, Finland

    Jarno Tikkanen

  2. School of Accounting and Finance, University of Vaasa, Vaasa, Finland

    Janne Äijö

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  1. Jarno Tikkanen
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Correspondence to Janne Äijö.

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Tikkanen, J., Äijö, J. Does the F-score improve the performance of different value investment strategies in Europe?. J Asset Manag 19, 495–506 (2018). https://doi.org/10.1057/s41260-018-0098-3

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