Harbour Asset Management is trialing a new qualitative overlay that in back-testing added up to 2 per cent of outperformance, Andrew Bascand told an adviser briefing in Wellington last week.
Bascand said the process rated the quality of companies according to a simple “binary” nine-point scoring system developed in 2002 by Stanford University professor, Joseph Piotroski.
While the ‘Piotroski score’ had been shown to be effective in other jurisdictions, Bascand said the research – carried out by Harbour investment analyst, Susanna Lee – was the first time the process had been applied systematically in New Zealand.
Lee compiled monthly data dating back to 2002 to recreate an historical Piotroski rating, known as the ‘Piotroski F Score’, on about 400 Australasian stocks (of which only 250 remain as listed companies).
“Just by removing the worst quality companies – which was about 40-50 stocks – that added about 1.5 to 2 per cent of outperformance above what we were already doing,” Bascand said.
He said Lee’s research indicated the F Score offered some promise as a qualitative overlay in Harbour’s portfolio construction process.
However, Bascand said the manager was still mulling over how to formally incorporate the F Score in the Harbour process.
“It is early days for us at the moment in considering how to mathematically overlay this indicator, for the time being we are tabling the data at our investment meetings,” he said.
If Harbour does implement the P Score, though, the manager would probably change its factor analysis methods, Bascand said.
“Logical candidates to replace or down weight are ‘balance sheet accruals’ and pure ‘return on equity’ as both are better captured in the F Score,” he said. “It is hard to say what weighting would follow or whether this could be better used as a screen.”
The F-Score was commonly used offshore, Bascand said, with a number of US funds, for example, structured around the method.
Piotroski first published a paper on his method to quantify quality in 2000, with companies scoring a one or zero across the following nine factors:
- Net Income: Bottom line. Score 1 if last year net income is positive.
- Operating Cash Flow: A better earnings gauge. Score 1 if last year cash flow is positive.
- Return On Assets: Measures Profitability. Score 1 if last year ROA exceeds prior-year ROA.
- Quality of Earnings: Warns of Accounting Tricks. Score 1 if last year operating cash flow exceeds net income.
- Long-Term Debt vs. Assets: Is Debt decreasing? Score 1 if the ratio of long-term debt to assets is down from the year-ago value. (If LTD is zero but assets are increasing, score 1 anyway.)
- Current Ratio: Measures increasing working capital. Score 1 if CR has increased from the prior year.
- Shares Outstanding: A Measure of potential dilution. Score 1 if the number of shares outstanding is no greater than the year-ago figure.
- Gross Margin: A measure of improving competitive position. Score 1 if full-year GM exceeds the prior-year GM.
- Asset Turnover: Measures productivity. Score 1 if the percentage increase in sales exceeds the percentage increase in total assets