Then it'll require a 2,000% return to come back, the stock has to multiply 20 times. Yes, just do the numbers yourself. So that is why we should also worry about how the capital structure of a form looks like. So the second component of Petrovsky's measure is capital structure. There are three scores that come from capital structure. The first one, called delta leverage. Now all of you know how to discern leverage. Different people use it to signify different things based on context. But in our context, leverage simply means the debt that a firm has taken. So the first measure of data leverage is nothing, but long term debt divided by total assets. If you see liability, I've not divided them into two parts here. There is one part which represents long term debt. There is a part which represents short term data. So take the long term part here, and scale it by assets. Assets of last year end of the last year or beginning of the year. So this number gives you delta leverage. Now that's the mechanical part. What does that mean and why this is important? And that's the purpose why we are doing this module. Otherwise, anyone can mechanically calculate these numbers. There's nothing grading this. So delta leverage again, since it is delta, it signifies a change. So change over previous pair, a positive delta leverage means an increase in long term debt compared to previous period. An increase in long term debt, is it a good thing or a bad thing? Normally, if someone asked me whether an increase in debt is a good thing or a bad thing, I will say that the information is insufficient. Just because the leverage has gone up doesn't mean that it's bad. Maybe the company has profitable projects, and that's why they had more on money. There's nothing wrong with that. However, come back to the context. What are the kind of firms that we are looking at? We are looking at firms, which are likely to be distressed. If a firm is already distressed, if a firm is not doing well, if a firm has been valued very low by the market. Market sees some danger signal ahead such a firm, if it starts increasing leverage, one should be alarmed. Lenders may see that's actually for default, and that may kill our business. Business is gone. So again, if business is gone, what is the value of your equity, all the way? Zero, exactly zero. So that is why, for a firm which is in distress which is not doing well, accumulating more and more debt is not a good news. So if delta leverage is positive, that means total long term debt divided by assets, long term liabilities divided by assets of last year minus the same ratio for the previous year. If the number is positive, you should give a score of zero. A form which has a negative number on this, you should give a score of 1, that is our fifth component. Now, the sixth one. Again, we didn't capital such as second one. Overall, the sixth one. This is called delta liquid. If it's in Piotroski's paper, you will find delta liquid, F underscore delta liquid. What does this mean? What is this liquidity? One, we have all ready done this, right? In a long term leverage, you've all ready done it. Why do we need to do liquidity? As I told you before, short-term debt is even more dangerous for a form which is already facing existential threat. I want to re-emphasize this point once again. It is not my case, it is not my point that debt, itself is bad, or I'm not saying that short term debt is bad. So any form you see a short term debt, you should straight away, go in short debt form. No, no, no, dont take that meaning out of this module. All that I'm saying is, if a firm is facing existing share threat. If the firm is in distress, such a firm accumulating debt especially short term debt is risky, it's better to stay away. That is what Piotroski tries to convey with this measure. So the sixth measure, overall sixth measure, and the second within this capital structure measure basically measures short term liquidity. So this is measured by a ratio called current ratio. I'm sure in your accounting goals, you would have learned about current ratio. What is current ratio? Current assets divided by current liabilities. What is current asset and what is current liabilities? You can pause a little over time and go back to your accounting module, but quickly let me tell you. Any asset, so I've written one item called assets. There are current assets and there are long term assets. Any asset which is convertible into cash quickly is current asset. Now what do you mean by quickly? So generally convention is to say within a year. If you can convert an asset into cash within a year, you consider such a set as current assets. Example, cash, it's already converted into cash. Say liquid securities, common securities, they're really cool, you can go and sell them at any time and get back cash. The receivables, so these are trade receivables where your customers owe money to you. These usually, the money comes back in three months. Of course, there could be some default there. But normally, you get money within three months. These assets get converted into cash, three months, six months, whatever, depending on the practice. And finally, the fourth one is stock. You have to maintain some level of inventory, right? For your business because certainly there could be some demand emerging from somewhere. You have to meet that, or supplies may take time. The inventory that you maintain is also considered current asset because the idea here is that you will sell it. It's not like a building, the building that you have is not expected to be converted into cash within a year. Whereas stock, the purpose is to convert it into cash. However, let me tell you in some books you will find that they do not consider stock as highly liquid. Because stock maybe stuck for the long time. These are definitely issues, as I've said before, we can play around with this. Our idea is to get the economic logic right and then start trading. If you find that excluding low stock works well for some companies, why not? That we're going to try later. So ideally cash, liquid securities, you have issuables then stock, and any asset that you think that is going to be converted into cash quickly, that forms a part of current assets. What are current liabilities? You should be able to think about it now. Yes, liabilities which you expect to pay within a year, they are current liabilities. So I have lumped together all liabilities here. But there could be long term liabilities, loans, 10 year loans, 20 year loans. And there could be trade credit for example which you have to pay within two months or three months, such liabilities or current liabilities. So this measure, current ratio is nothing but the ratio current assets divided by current liabilities. So you get this for current year and you calculate the same for the previous period and take the difference. Now you have to guess, how the scoring should be? If the difference is positive what you should do? Will you score it as one or zero? Remember, when it came to long-term debt, if the number was positive we gave it a score of one. Should we do the same thing here or should we not? The answer is, we should not. Why? Because what is there in the numerator now. Current asset is in the numerator, not liabilities. So an increasing score means relative value of current assets when compared to current liability has increased in this period when compared to last period. Please note this. Why I'm emphasizing on this again and again? The reason is your understanding of this Piotroski score should not be mechanical. You should not just say that this ratio, this number, no. Even in order to this number, suppose I give you current liabilities by current assets. Then you should be able to say in such a case, a positive number is zero, a negative number is one. That is possible only if you understand the economics behind this and not mechanically calculate this looking at some score, that is why I am emphasizing on this. Hope you appreciate this. Now so an increasing current effect, current ratio, I'm sorry, is positive. So now we're done with the sixth element of Piotroski's f score. Let's move on to the seventh one, the seventh one is a bit ad-hoc, but there is an economic logic also here. This is called EQ_OFFER, that's what petrowskys was, equity offer this is coming from a lot of value westors, famous value westors. They believe that a business, that requires repeated investments from the entrepreneur is not a good business. A good business is one where you make some investment and then it starts giving you returns. But if the business is such, think of the utilities, you have to keep investing, you have to keep buying big assets, you have to keep putting money, such a business is risky. So EQ_OFFER is nothing but a Piotroski ask just go and verify whether the form has raised equity capital. So if we are talking about debt, equity capital in the last one year. Again, please do not think that raising a equity capital or raising debt itself is bad, generally no. In fact, in lot of cases if a farm is able to get funding from investors, it may be a positive sign. But within our renewals, our renewals of distressed firms, firms whose survival is at stake. Repeatedly raising money may not be a good sign. Again you may debate that someone may say that a fact that an investor is willing to invest in such a firm is a good sign possible. I would encourage you to come over and try giving a positive score to such forms. But in this module, our purpose is to inform you about Piotroski score. In Piotroski's f score, raising equity repeatedly is not a good sign. So if you find a firm raising money in the last 12 months through equity, what will you do? You will give it a score of zero, otherwise a score of one. So now we are done with all three capital structure ratios. So we have four profitability ratios, and we have three capital structure ratios. Now we have to look at two more of them, which are efficiency measures. So there are two efficiency measures that Piotroski uses, the eighth and ninth measures. The first one is known as delta margin and sorry, I drew delta wrong. Delta margin, and the second one is delta turnover. Moment you see this delta, you should know that we're talking about change. Now, I'll write a simple equation. So we saw ROA, right? What did we see ROA? Profits, yeah, I know that it's operating profit, we exclude extraordinary. Assume that this profit is operating profit divide by total assets. Let's look at this carefully. Can we write this one as profit divided by sales, and this times sales divided by total assets. Is this right hand side and left hand side the same? Observe carefully. We can cut the sales, right? This sales and this sales. Basically, you're left with what? Profit divided by total assets. Now why am I doing this excercise, you may be wondering. It's simple and straight forward, why am I doing this exercise at all? It is important because there is an economic meaning to these two ratios. This part represents what an honest margin. If you sell a 100 rupees or a $100 worth commodity or some good. What is the margin that you want to make? So this is margin, profit margin. Why is this important? This is really what kind of business you are in. A good business is one where profit margin is high, very intuitive. If your profit margin is very low, if you're working on tin margins. Such a business is likely to be a highly competitive business. Now just forget about economics 101, where you were taught that profits are likely to be zero in a competitive business. I'm not talking about that profit, I'm talking about accountive profit here. If the accounting profit is very, very low then this is not likely to be a very good company, just looking in margin. So we want this to be high, what is the second component? Second component is sales by total assets. Can you think about economic meaning of this? This si known as turnover. Now what does this mean? How many times assets turnover in a year? Why this is important? Because this measure tells you how good the firm is in terms of assets utilization. In other words, higher this ratio, better it is. The form is utilizing assets well. So margin into turnover or margin times turnover gives your ROA. So in the third category of measure, Piotroski's measures, he breaks down ROA into two parts. Delta margin and delta turnover. Now it is simple, right? By now you are used to it. You should be able to complete this based on what you just saw. If you see margin improving over last period, what you should do? Give a score of one. Similarly, if you see turnover improving over last period, what you should do? Give a score of one. A decline in margin will get you a score of zero. A decline in turnover gets you a score of zero. So these are the last two components of Piotroski ratio. So delta margin and our delta turnover. These tell you about operating efficiency of the firm. So to summarize, Piotroski measure has three parts. Profitability measures, then you have capital structure measures and then your efficiency measures. The first four ratios, what are those? ROA, CFO, which is cash flow from operations, delta ROA, change in return on assets and accruals. These four represent profitability measures. Then you have the other three, which are capital section measures. Now we discuss them, delta leverage, current ratio, change in current ratio, and whether the firm raises equity or not. And finally, we have delta margin and delta turnover as efficiency measures. So now with this background, after this module. If I give you a balance sheet and income statement and cash flow statement of any firm. You should be able to quickly, of course, you need for two years, you should be able to quickly calculate the f score for any given firm. And f score can range from, yes, range from? Yes, 0 to 9, [COUGH] and qualitatively the higher the f score, better is a firm's fundamental. Firm fundamentals are improving, if they have scores higher, that's the interpretation. Lower their score, not so good, other fundamentals. So if you understand this, now you are ready to actually design a trading strategy based on this. So after each module, I keep telling you, you are entering the most exciting part of this paper, now it is actually true. Now once you learn the module, I'm sorry, learn the scoring, learn the algorithm. Now you are ready to actually devise the trading strategy. In other words, now we are ready to research what stocks to buy and what stocks to sell and start trading based on Piotroski. So that is what we are going to do next.