Joseph Piotroski is famous for creating the F-Score, an accounting-based fundamental analysis and stock-picking strategy that assesses firms along nine financial dimensions. Generally speaking, if a firm achieves a perfect score, its financial picture is improving, and there are statistical reasons to believe it may be undervalued.
When I ran Piotroski’s F-Score screen on today's market, I generated a handful of stocks with perfect scores, including National HealthCare Corporation (NHC), which operates long-term health care centers and assisted living and independent living communities, and provides nursing and rehabilitative care, along with a variety of additional health care services. Piotroski's F-Score is particularly effective on smaller capitalization companies, and at <$500mm in market capitalization, NHC fits the bill.
Turning to our NHC output on the Recent Operation Improvements screen, we see the factors that make up the F-Score:
NHC is improving A/R and asset turnover ratios, which suggests the firm is using its assets more efficiently, and the quick ratio is improving, reflecting a strengthening working capital situation. Revenue, gross margins and net income are also improving. Returns are going up: returns on assets and capital are improved versus the prior year. Finally the firm shows an improvement in debt/capital, which implies a lower risk of financial distress and less risk to equity cash flows. In short, the firm seems to be doing many things right.
Turning to the Shareholder Yields output, we see the following:
TTM and normalized (trailing 8yr Average) EBIT to TEV yields are in the mid- to high-twenties range, placing the firm in the 97-98%ile of firms in the screening universe, suggesting you are getting a lot of cash flow versus what you pay for the enterprise. Short- and long-term free cash flow also looks strong, with a TTM FCF/TEV yield of 22%, and normalized (8 yr Average) FCF/TEV of 16%. In both these cases, the firm is in approximately the top 6% of the screening universe. Book to market stands at 123%, placing it in the top 11% of firms in the universe, meaning the firm trades significantly below the book value of its equity. If the book value of assets is reflective of what you could actually sell those assets for, the firm could offer a strong margin of safety, since the equity could potentially be worth more in liquidation than you are paying for it today. Finally, normalized (8yr Average) net income/market cap yield (reciprocal of P/E) is 7.8%, which places the firm in the top 16% of the screening universe. NHC's Valuation score of 90.1% is flashing a buy signal.
Looking over other categories within our output, I noticed that the firm scores below average on our Earnings Manipulation And Fraud Detection Screen, with an aggregate Earnings Quality score of 47.5%, as seen below:
Reviewing the percentile scores column within the screen, you can see the firm does not fare as well as before. Accruals, which are simply net income - operating cash flow, are showing a poor relationship to assets, placing the firm in the bottom third of the screening universe. There also appear to be accruals creeping into earnings, as a significant amount of net income realized by the firm is not flowing through the cash flow statement; at -18.4%, the company's accruals/net income relationship places it in the 41%ile, which is a poor showing versus the rest of our screening universe. Why should this be? There could be many good accounting reasons for these accrual results, but there are also a number of potentially less good ones.
Here is an opportunity for a fundamental analyst to roll up his sleeves and do some deeper digging into the numbers. While NHC exhibits many of the healthy characteristics of an improving financial situation, and is certainly cheap, there are some unanswered questions relating to the impact of accruals on the financial results.