08) Stock Picking Strategies: CAN SLIM

by · October 16, 2010

William O’Neil developed CAN SLIM which is a method of screening, purchasing and selling common stock.  It is described more thoroughly in his book “How to Make Money in Stocks”.

It is actually an acronym for a very effective investment strategy.  It pays heed to a company’s tangible factors such as earnings while at the same time looking into its intangibles like strength and ideas.  Let us take a look at the seven components of CAN SLIM

C = Current Earnings

O’Neil states that investors should look for a stock that has earnings per share (EPS) in the most recent quarter that has grown on a yearly basis.

  • How much growth? – O’Neil suggests 18-20%.  Although this is just a rule of the thumb, there are performers which range on 50%.
  • Earnings should be examined carefully –  A good investor should know how to recognize low quality earning figures. Because companies can manipulate their figures, an investor must be prepared to do some investigating and learn to look past the numbers companies put forth.

Once you get a fair idea of the quality of a company’s EPS, look to others in the same industry.   A solid growth in the industry can indicate that the industry is thriving.

A = Annual Growth

CAN SLIM indicates that a company should have good annual growth over the last five years.

  • How much is annual growth? – Something within the 25-50% range is ideal.

Wal-Mart for example is a company that has good annual growth that preceded a large increase in stock prices.

Current earnings and annual growth are some of the fundamental steps in quantitative analysis.  They are usually a good basis for a good stock pick.

N = New

For O’Neil, a company that has undergone changes necessary in order to move forward.  Whether it be new management, new equipment or new policies; change necessary for a company to become successful.

Take McDonald’s for example.  The franchise strategy enabled its 1100% growth during 1967-1971!  This is just one example of a company that employed change and was able to reward its shareholders along the way.

O’Neil says that it is human nature to steer away from stocks with new price highs. People are always afraid that a company at new highs will have to trade down from this level. However,   historical data  indicates that stocks that have just reached new highs often continue on an upward trend to even higher levels, according to O’Neil.

S = Supply & Demand

Supply and demand affect all market activities.  If all things were equal, it is easier for a small firm to show outstanding gains.  This is because large companies have more demand compared to small companies and will require more to demonstrate the same gains.

Large investors also lack liquidity which restricts them to only buying large cap blue chip companies.  This leaves them at a disadvantage which small individual investors can take advantage of.  If the stock market capitalization is smaller, the large transactions the institutional investors make can affect share price because of supply and demand.

In his study, O’Neil found that 95% of the companies displaying the largest gains in share price had fewer than 25 million shares outstanding when the gains were realized.

L= Leader or Laggard

In the stock market, there are those who lead and give good returns to their investment and then there are those who lag behind and provide mediocre returns of investment.  You need to separate these two.

  • Relative Price Strength –  O’Neil suggests looking for stock with that has a relative price strength of at least 70, though the ideal is in the 80-90 range.
  • Sympathy and laggards – Don’t let your emotions make your picks.  Cheap stocks are cheap for a reason.

I = Institutional sponsorship

A stock worth investing in should have at least 3-10 institutional owners.  This is based on the idea that a company without institutional sponsorship would have passed over the thousands of institutional money managers.  However, be wary of stocks with too many owners.  Any bad news could trigger a spiraling sell-off.

M = Market Direction

When picking stocks, identify what market you are in.  Are you in a bear or bull market.  Not knowing what market you are in could mean that you might be investing against the current market trend.

  • Daily Prices and Volume – keep track of market conditions by watching the daily prices and volume movements of stocks.  Employ technical analysis tools when needed especially when determining trends.

The CAN SLIM Criteria:

C = Current quarterly earnings per share – Earnings is up at least 18-20%.

A = Annual earnings per share – Meaningful growth for the last five years.

N = New things – Buy companies with new products, new management, or significant new changes in industry conditions. Forget about cheap stocks; they are cheap for a reason.

S = Shares outstanding – Preferably a small and reasonable number. CAN SLIM investors don’t opt for older companies with a large capitalization.

L = Leaders – Buy market leaders, not laggards.

I = Institutional sponsorship – Buy stocks with at least a few institutional sponsors who have recent records that are better-than-average.

M = General market – The market will have the final word whether you win or lose. Learn how to recognize the market’s overall current direction. Interpret the general market price and volume changes and action of the individual market leaders.

Conclusion

CAN SLIM incorporates all the different criteria of the different strategies involved in stock picking.  It provides clear guidelines when picking stocks.   It is a combination of value, growth, fundamental and technical analysis.

Tags: