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An Accountant Looks at the Market
(Continued)
Nuts and Bolts
The scale that Piotroski developed measures profitability by rating
return on assets, cash flow, the difference between the current
and prior year’s return on assets, and the difference between
the current and prior year’s cash flow. Next comes capital
structure. To screen this, Piotroski measures the ratio of long-term
debt to total assets in the past year, the historical change in
the firm’s ratio of current assets to current liabilities
at fiscal year-end, and the amount of common stock issued by the
firm. Finally, Piotroski measures operating efficiency by rating
the prior year’s gross margin improvement and asset turnover
(net sales divided by average total assets) improvement.
Piotroski clearly is pleased with the success
of his accounting approach toward investing. “This is the
type of analysis I like to do. It’s the approach I teach
my students. And,” he confessed, “I think I’m a
value investor at heart.”
His latest reward is watching students apply his
work. “I now have a lot of former students who have internships
or full-time jobs, and they’re running screens that are similar
to mine. I think that’s great because they’re taking
my research to the real world to see what happens.”
Corporate Transparency Matters
Piotroski currently is looking at whether corporate transparency
matters in the development of efficient capital markets. In the
United States, as well as in many western European countries,
corporations are legally obligated to be “transparent”—to
disclose financial information, cooperate with auditing procedures,
and follow government business regulations. “But,” Piotroski
notes, “when you look at developing countries, the accounting
and reporting standards are a lot more opaque. Either accounting
and information dissemination activities aren’t regulated,
or the regulations aren’t strong or the rules aren’t
enforced even though they may exist.”
Piotroski and his colleagues want to find out
if greater corporate transparency has a positive effect on U.S.
capital markets and whether better regulations abroad would help
markets in developing nations. Although results are preliminary,
he said, it appears “the better the information environment,
the more efficient the capital market formation process is.”
Piotroski’s other research project examines
the consequences of the Security and Exchange Commission’s
new Regulation FD that took effect in October 2000. It mandates
corporations to disclose information to the
entire public, not just to analysts and financial institutions,
as they had in the past.
“Before,” Piotroski explains, “company
officials used to have closed conference calls with analysts or
brokerage houses and give them background information that would
affect stock prices and trading behavior. But the average investor
didn’t hear it. Enacting Regulation FD was the government’s
way of saying all investors are equal and all deserve equal access
to that information.”
When the regulation was first proposed, “Corporations
were concerned that making such disclosures would cause prices
to jump around because the public would react emotionally,”
Piotroski remembers. He set out to see
if these corporate fears were well founded and learned that voluntary
disclosure activity does lead to heightened market volatility.
“But it’s not the fact that you do disclose,”
Piotroski points out. “It’s more how you disclose that
affects the market.”
Specifically, uncertainty about the implications
of a forward-looking earnings statement leads to the heightened
volatility. The more a manager increases the precision of the
forecast, the lower subsequent volatility will be.
In other words, Piotroski found that the public
reacts less dramatically if information is presented in a thorough
fashion. While preliminary, his findings may interest in-dividuals
whose job is to disclose data about a corporation.
Getting hold of the right information is the key
to dealing successfully with the stock market. Just ask Piotroski.
—Patricia Briske and Allison Benedikt
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