financial health screen

     This financial health screen was developed by Joe Piotroski, Assistant Professor at the University of Chicago and a former University of Michigan PhD student.  The idea behind the screen is to start with a large pool of value firms and then remove the ones that are likely to experience financial distress.  The algorithm is as follows:

a) rank all actively traded stocks on the ratio of Price/Book Value and keep the bottom 20%.

b) construct the financial health index, giving 1 point for each desirable attribute:

1. net income > 0

2. cash from operations > 0

3. DROA > 0

4. cash from operations > net income

5. D(long term debt/average total assets) < 0

6. D current ratio > 0

7. no equity issuance in most recent fiscal year

8. D gross margin > 0

9. D asset turnover > 0

c) the screen recommends buying stocks with a financial health index of 8 or 9 and selling stocks with a financial health index of 0 or 1