INVESTOR EDUCATION SERIES
IDENTIFYING
GROWTH STOCKS
CANSLIM
STRATEGY
“CAN SLIM” refers to the seven-pronged mnemonic developed by Investor's Business Daily editor William O'Neil, as a checklist for identifying Growth stocks.
It is one of the safe and sure methods of identifying Growth stocks in a scientific manner. The strategy involves both technical analysis and fundamental analysis.
CANSLIM strategy tries to identify fundamentally strong stocks - and encourages buying them at the appropriate time - when they emerge from price consolidation periods and before they advance dramatically in price.
The seven parts of CANSLIM mnemonic are as follows:
C stands for Current Quarterly EPS : Current earnings should be moving up QOQ significantly, preferably by 25% or more. Earnings must exclude one-time items, special items, such as the sale of a plant or the settlement of a lawsuit or anything that skews comparison. As earnings growth becomes stronger each quarter, it often attracts the attention of professional investors like mutual funds, hedge funds, pension funds and banks.
A stands for Annual earnings :Annual EPS should have moved up 25% or more in each of the last three years. Annual returns on equity (ROE) should be 17% or more. Earnings growth, both annual and quarterly, is the No. 1 indicator of a stock's potential to make big gains. In the absence of earnings growth, annual and quarterly, no stock can be a Growth stock. Many search for winners among low EPS Low price stocks, rather than the obvious winners which can be located through CANSLIM technique. CANSLIM METHOD considers this a waste of time. It is usual for some to look for STOCKS WITH LOW PE RATIOs which are considered likely to move up soon. This is not necessarily always the correct approach. Some of those which have higher PE ratios are likely to be having faster growth ratios of EPS etc, which ensure their future, FASTER GROWTH as well. Quality usually carries such a higher price. But, it pays quickly.
N stands for New product or service : Stocks double, triple or quadruple in price - usually because of a breakthrough product or service that fuels their advance. Look for a new basic idea, product or service that is fuelling their earnings growth.
Success isn't about luck. It isn’t about cutting costs and then waiting for “things to turn around.” Rather, it’s about innovation. As soon as one new product is introduced, winning companies are working on the next upgrade or new ways to sustain their leadership.
Or, it may be complete rethinking of current ideas, or introducing a new corporate culture under a new, dynamic leader or a drastic change in international industry conditions. The right leader can make a big difference for a company and its investors. On the flip side, inept management can turn a company’s stock into a laggard. In respect of companies under great leadership or with great innovations, a higher current price should not discourage us from buying. But, we must avoid stocks that make new highs on declining trading volume. That’s a bearish sign. Also, we must be wary of stocks that inch to a new high on heavy volume without much upside price progress. That stalling is a sign of selling pressure.
S stands for Supply and demand : Trading volume of the stock, which represents the supply and demand in BUYING and SELLING must be fairly good. When a stock’s price climbs sharply, we want to see its daily trading volume rise as well. That shows us that institutional investors like mutual funds and hedge funds are buying. If volume is below average, it tells us that big traders aren’t behind the move and the stock may not be able to hold onto its gains. And when a stock’s price drops, we want to see light volume - that tells us there’s no significant selling pressure. But if a stock’s price plunges as its volume surges higher, it’s a sign big investors are heading for EXIT. And we might want to follow their lead. This means that - Price increases should be accompanied by increases in volume. That shows us that institutional investors are buying in. Also Price declines should come in lower volume, which tells us there’s no significant selling pressure.
L stands for Leader or Laggard : Buy the " leading stock in a leading industry". We can keep our eyes on 2 or 3 leading stocks in each leading Industry. Here, identifying LEADING INDUSTRY (a few of them) is the first step and identifying leaders therein is the second step. Steer clear of stocks that are laggards. They will most likely remain laggards. In the stock market, do not go for the sad-looking stocks at the bottom of the pack. In a bull market, stocks that are doing the best tend to keep doing well, while those slumping are likely to drop further. A leading company with a cutting-edge product, a much-needed service, or a company that comes from an in-demand industry will pull to the front of the pack.
I stands for Institutional sponsorship: Usually, leading MFs, FIIs, DIIs etc try to get the latest developments unknown to ordinary investors. When it comes to investing, it pays to watch these pros. Institutional investors dig deep for information before they invest in a company, and once they do, they keep a close eye on their investment. Their analysts and researchers study the firms they put their money into, meeting with top executives, evaluating industry conditions and gauging the firm's outlook.
Because they have millions - and often billions - to invest, their decision to buy or sell a stock can determine the stock’s fate.
If they choose to buy a stock, their increased demand for its limited supply of shares can push its price higher. Conversely, their decision to unload their holdings can send its price tumbling.
That's good news for individual investors. If you can learn to spot the signs that institutional investors are buying a stock, you can follow their lead. Among the fund managers too, spot the best and most successful – and try to follow their leads. You want to run with the winners, not the also-rans.
M stands for Market indexes: O'Neil prefers investing during times of definite uptrends of major indices.
A good strategy is to follow the market’s general flow and make the trend your friend. In other words, buy when the market’s in an uptrend and sit on the sidelines when it’s working through a correction. When we talk about the stock market or the general market, we’re usually referring to one of the major stock market indices. These consist of companies from a range of sectors and industries. Some indexes are made up of smaller stocks, others are home to bigger, more established companies. By watching the indices, you’ll get a well-rounded perspective of the overall market:
Different sizes and types of stocks will lead the indexes at different times. Some times, stocks with smaller market capitalizations may pull ahead. Another year large-caps may have the upper hand.
Market capitalization describes a company’s size. It’s calculated by multiplying the number of shares outstanding by the share price. It pays to follow the market’s trend and recognize which size market cap stocks are scoring the biggest price gains.
CONCLUSION : According to the American Association of Individual Investors (AAII), between January 1998 and December 2008, market portfolios traded according to CANSLIM principles gained an average of 1,351.3%, versus a loss of 6% in the S&P 500, with gains made every year regardless of bull or bear market performance.
The CANSLIM strategy emphasizes cutting all losses at less than 7% or 8% below the buy point, with no exceptions, to minimize losses and to preserve gains. O'Neil particularly emphasizes that you have to use the whole strategy including the cutting of losses part.
Well, obviously, CANSLIM calls for a lot of preparation before investment and a lot of watching after investment. Also, we may agree with many parts of it – but not with some parts. This is possible. For instance, BUY LOW, SELL HIGH is a popular saying in stock market. CANSLIM shows how to beat the Ups and DOWNs on a long term – but not about BUYING LOW or selling HIGH. All said, it certainly is a great method for identifying sure shot (almost) winners in the stock market
Other Articles in CUSTOMER EDUCATION SERIES can be read at the following URLs :
1. 1. MONEY FASCINATES:
2. MARKET INVESTMENT : ESSENTIAL RULES FOR SUCCESS:
3. SELECTING A GOOD SCRIP FOR INVESTMENT
4. INVESTMENT STRATEGIES OF WARREN BUFFET: (5 ARTICLES)
6. WORDS OF WISDOM FROM WARREN BUFFET:
7. DOLLAR (RUPEE) COST AVERAGING :
8. PRICE TO EARNINGS RATIO :
9. GROWTH STOCKS vs VALUE STOCKS :
10. PRICE TO BOOK VALUE RATIO
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