Hello, welcome back. Now in this lecture we discussed with Trotsky f score. We will go through the entire formulation as done by Trotsky in 2002 and how they are applied to value forms. This is a slightly long lecture, so feel free to pause the video whenever it's necessary for you and go back and forward as and when it is required for you. As a bottom line with Trotsky's f score is a number between zero and nine, which is used to assess the strength of a company's financial position, zero being the least favorable and nine being the most favorable. Petrovsky f score is used for financial investors in order to find the best value stocks to invest in Petrovsky f score is named after Professor Joseph Petroski who formulated this paper in the year 2002.

Before we start discussing the formulation of the F score, let us go through the abstract of the Petroski paper as published in 2000. To in any financial doc document or white paper which is published, it is very important to go through the abstract abstract gives you the complete story of what is the whole paper discussing about. So, it is very important to understand the abstract to understand why and how to apply the papers contents are provided here the abstract as is present in the paper written by Joseph Petroski. It will be a good idea to pause the video and go through the abstract. I will read the abstract for you and go through the important points as is discussed here. The paper examines whether a simple accounting base fundamental analysis strategy, when applied to a broad broad portfolio of high book to market firms can shape the distribution of returns on by an investor.

Now, the important point to note here is high book to market firms. We know that value stocks have a characteristics that they have a low price to book value. Now, the price to book value is the market value divided by the book value. Now, the opposite of that is the reciprocal of that is book value divided by the market value. So, if the price to book value is to be low, then it means the firm has to have a high book to market value. This establishes the fact that Petroski is discussing value stocks.

The abstract further reads, I showed that the mean return on via high book to market investor can be increased by at least 7% annually through selection of financially strong book market firms, while the entire distribution of realized returns has shifted to the right. In addition, an investment strategy that buys expected winners and shorts expected losers generates a 23% annual return between 1976 and 1996. And the strategy appears to be robust across Time and to control for alternative investment strategies. Now, a few things are very significant here. First thing is that the paper discusses about value for value stocks. Then the paper says that if we buy the expected winners and sell shorting means selling, sell the expected losers, we can generate 23% extra returns, as was shown between the time period that Petroski studies the most important aspect what the paper says is that the strategy appears to be robust across time.

So we can still apply the Trotsky's formula in our modern times. In fact, it is very applicable in emerging markets like India, etc. I leave it to you to read the rest of the abstract. I would encourage you highly to read the complete paper it is available in the internet in Petroski is formulation of webs code Petroski has ideas state that we evaluate each stock. Here we must remember relative value stock. So evaluate every value stock or nine parameters.

On each parameter, we will give a score to the stock. On each parameter, a stock gets a score of either zero or one, there is nothing in between. So either the score is one or it is a zero. So Petroski safe score is always an integer between zero and nine. So the stocks can earn a number between zero and nine higher the number mode the number towards nine or nine itself. The stock is supposed to be a better purchase.

Now we'll discuss each of the nine parameters. Before we start discussing the parameters, let us take a stock which we will use as an example. This will help understand the Petroski parameters much better as we will be discussing real numbers from the annual reports This particular stock. Now the stock which we have taken is Gujarat, alkalis and chemicals limited. You see the the P is 4.89. So it's a low p, the PV is also 0.95.

It's a low PB. However, the dividend yield is also very low. So we can consider this as a value stock though in our formulation, it doesn't fully qualify as a valid stock. It should be noted that Petroski only considers PB as the parameter based on which a value stock is identified according to Petroski. So, we can consider this stock because the PB is very low. Petroski says the high book to market value stocks are value stocks.

So this is a high book to market stock. So we can consider this as a value stock. We will consider this example of wizard balconies and chemicals for discussing the various parameters of Petroski. The first parameter is ROI. return on assets now return on assets is calculated as net income before extraordinary items divided by total assets at the beginning of the year. The piekarski uses the assets at the beginning of the year.

Normally we calculate our way as net income divided by the total the average of the total assets of the previous year and the current year. However, Petroski considers total assets at the beginning of the year. Now if our figure is greater than zero Petroski assigns a value of one otherwise he assigns a value of zero. Now, we know that if return on assets is increasing, then either the net income is increasing or the average total assets is decreasing. The company can arrive at a high ROI either by boosting a profit margin, or by more efficiently using the assets. The higher the IRA the better it is for the company, because the company is earning more or less investments from the annual report of Gujarat alkalis and chemicals limited for the year 2000 1718 I gathered that the net income before extraordinary items is about 79,000 crores and the total assets at the beginning of the year 2017 18 was about four and 43,000 crores.

So the auto a for goodness alkalyn and chemicals limited works out to 0.178 so the array is greater than zero and so on the first parameter of our array we give a score of one to Google's algorithm and chemicals limited. The second parameter Petroski is consider this cash flow from operations. We know that a high cash flow indicates that the company is earning higher revenues it has got lower overheads and the efficiency of the company is higher. cash flow from operations can be calculated as cash from operations divided by total assets at the beginning of the year. Notice that PLC considers total assets again at the beginning of the year if the cash flow from operations is greater than zero Petroski sciences score of one. Otherwise he assigns a score of zero from the annual reports for 2017 18 I gathered that the cash from operations is nearly 251,000 crores.

So, for goodness alkalyn and chemicals limited, the CFO works out 2.566. Now again CFO is greater than zero. So we assign a score of one to 30 Truscott parameter is delta r delta r is the difference between the current era and the previous year's ROI. We know that ROI means that how much we are earning on the assets that we have got. So, higher the ROI means that we are having more income from lesser amount of assets. So, if this trend is on the increase, then Petroski gives a score of one.

So, if the delta is greater than zero then Petroski assigns a score of one otherwise he assigns a score. have zero. Now we calculate delta array for budget calculations and chemicals limited. We had found that the current year's ROI was 0.178. Now, from the annual reports of 2016 17, I gathered the figures for the for calculating the previous year's ROI. So the previous year's ROI works out to 0.119.

So delta alpha is 0.178 minus 0.119 which works out to 0.059. So, delta aro is greater than zero and does good job alkalyn and chemicals limited scores or non Delta airway. The fourth Petroski parameter is accruals accruals are basically the services which have been rendered services or products which have been rendered. However, the cash has not flown into the company as a result of that services of the product delivery. No accruals basically means that the company has got money on the books, but the money is not realized yet. So if the accruals are high, then there's a chance of default as well.

It may be possible that the company has actually done the work, but the money it cannot receive, because the repaying party does not honor the contract. We had a recent case in India where reliance in telecommunications was not paying Ericsson a sum of nearly 700 crore rupees for many years for those equipments which had bought from Ericsson. So, companies with high accrual is seen as a risky company. Actual can be calculated as cash flow from operations minus return on assets. So, if approval is greater than zero assign a value of one, otherwise assign a value of zero for Gujarat, alkalis and chemicals limited we already calculated that the cash form of cash flow from operations is 0.566 and the return assets is 0.178. So 0.566 is greater than 0.178.

And thus, the CFO is greater than outweigh. So on the accruals front, we give a score of one two without alkaline sand chemicals limited Petroski fifth parameter is delta leverage. Delta leverage basically measures the increase or decrease in debts in the current year over the previous year. So delta leverage is calculated as current year long term debt divided by average total assets of the last two years minus the previous year's long term debts divided by the actual average total assets for the last two years. Now, if delta average is greater than zero, it means the debts have increased in the current year over the previous year. So it is seen as a negative sentiment.

So Petroski assigns a score of zero if delta average is greater than zero. And if delta leverage is leverage is less than zero, it assigns a score of one From the annual reports of Gujarat, alkalis and chemicals limited, I gathered the figures of current year long term debts and the previous year's long term debts. Also, I gathered the total assets in 2017 2016 and 2015. Now we put these figures into the formula for delta leverage, advocate a Delta leverage of 0.012. So the Delta leverage is greater than zero. So good alkalis and chemicals limited scores is zero on the Delta leverage parameter.

The sixth parameter is delta liquid, delta liquid is calculated as current ratio of the current year minus the current ratio of the previous year. We know that the current ratio is the ratio of current assets by current liabilities. So current ratio basically indicates the company's ability to pay its current short term debts. Now, if the current ratio current ratio is greater than the previous year's current ratio, that means the company has better abilities to pay short term debts as compared to the last year. If it is less than the current ratio, the current ratio the current ratio the previous year, it means the ability to pay short term debts is reduced. That's why Petroski says if the decorator liquid is greater than zero assign a score of one otherwise assigned a score of zero.

From the annual reports of Gustav alcoholism chemicals, I have gotten the current asset and the current liabilities of the current year and the current assets and current liabilities of the previous year. So using these triggers, we can calculate delta liquid and the Delta liquid works out to be 0.187. So delta liquid is greater than zero. So we assign a score of one to the parameter Delta liquid for Gujarat alkalization chemicals limited Petroski seven parameter is equity capital. equity capital is the amount of equity offered in the current year. So because Petroski says that if he could, he kept is less than equal to zero assigned zero, otherwise assigned one.

In the financial year 2017 18. The equity share capital for balconies and chemicals Limited is greater than 7000 crore rupees, so the equity capital is greater than zero and thus to assign a score of one on parameter seven for Gujarat, alkalis and chemicals limited. parameter number eight is delta margin. Delta margin is calculated as gross margin ratio of the current year minus the gross margin ratio of the previous year. The gross margin ratio is calculated as gross margin divided by total sales. Now if the Delta margin is greater than zero, we assigned a score of one, otherwise we assign a score of zero.

For goods that alkalis and chemicals limited I gathered the figures of gross margin total sales for the current year and the gross margin and total sales for the previous year from the annual report now then putting into the formula For Delta margin, we get the Delta Martinez 0.0702. So delta margin is greater than zero does without alkalis. And chemicals limited gets a score of one on the parameter Delta margin. The ninth and the last parameter is delta turnover. Delta turnover is calculated as asset turnover ratio of the current to minus asset turnover ratio of the previous year. asset turnover turnover ratio is calculated as total sales divided by total assets at the beginning of the year.

Now, if turnover Delta turnover is greater than zero, we assign a score of one. Otherwise we assign a score of zero. From the annual reports, we had already gathered the figures of total assets for the previous year. And we had already gathered the figures for total sales for the current year and for the previous year both. Now putting these values into the formula for delta turnover. We get data turnover as 0.023.

So delta turnover is greater than zero. So goes that alkalis and chemicals limited gets a score of one on Delta turnover. So we have gone through the nine parameters of Petrovsky f score. These nine parameters are devised by Petroski to generate what he called the F score. The Nine parameters were read return on asset, cash flow from operations, delta RA, accrual, delta leverage Delta, liquid equity capital, delta margin and delta turnover. For future illustrations, we will codify each of these parameters as f1, f2, etc, up to F nine.

Now for the stock, good job alkalis and chemicals limited, we evaluated all the nine parameters and got the values what we required from the formula what was given by Petroski. Based on these value values we extracted we gave a score to each of the parameters which are shown in this table. Now to do Under the EPS code, we just add up all the scores for the individual parameters and arrive at their score. So for Gouda balconies and chemicals limited the F score is eight. So according to Petroski, they should be a very good value stock. With this we have seen how to calculate the F score for a particular brand a stock.

Thank you for listening. See you in the next lecture.