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Using the CANSLIM Stock Strategy to Screen Stock Purchases

By: , dated January 25th, 2013

The stock market can make or break dreams in a single afternoon. While stock strategies abound, there is no
concrete system that will minimize risk while maximizing returns every single time. As with any investment,
the stock market carries with it a certain degree of risk, regardless of which stock strategy investors choose.
Equally true is the fact that some stock strategies are superior and safer than others. The strategies which tend to work best are those which carefully select stocks based upon vigilant analysis and research. Originally developed by William O’Neil, the CANSLIM stock strategy employs a prudent analysis of earnings and other financial information while also assessing the relative strength of the company and its potential for future growth in earnings. In other words, the CANSLIM strategy looks at both tangible and intangible items when screening potential stock purchases.

C = Current Earnings

Earnings may not be the only important indicator of the current strength of a company but they certainly provide useful information to help in the decision-making process. The CANSLIM stock strategy requires a careful analysis of the most recent earnings per share (EPS) reported by the company. Not only should those earnings be higher than they were in the same period the year before, they should be trending upward on an annual basis as well (in other words, one quarter of substantial growth is not enough and could very well be some sort of anomaly). A CANSLIM stock strategist generally likes to see current earnings rise by 20% or more before considering a company to be a viable investment option. However, much larger increases are always welcome. In the years between 1953 and 1993, nearly 75% of the top 500 best performing stocks (not the S&P 500) experienced an earnings increase of an average of 70% prior to significant rise in stock prices.

A = Annual Earnings

Although current earnings will tell investors where the company currently stands, annual earnings tend to paint a more complete financial picture. CANSLIM stock strategists will look back 4-5 years to see if annual earnings have been increasing at a healthy rate. Most investors using CANSLIM tend to prefer companies with annual earnings increases in the 25-50% range. Companies with better-than-average returns tend to see their stock prices rise rapidly, which is why CANSLIM investors target such businesses. However, it is recommended that investors also compare earnings with other companies in the same industry. If the earnings increases are strong and better than the rest of the competition, then the company is in a good position to have a strong period of growth, and therefore, be a sound investment.

N = New

Companies, much like people, can get stuck in a rut. Without innovation, a company will eventually die. But before it does, it will see its stock prices plummet, and take any investor still clinging to it down as well. Consequently, CANSLIM stock strategy emphasizes the importance of new ideas to a business. In fact, the “new” in CANSLIM may refer to a new product, entrance into a new and untapped market, or perhaps even a recent management upheaval. Any new factor that can provide a clearer picture of where the company is headed will aid in stock selection.

S = Supply/Demand

Actually, it might make more sense for the “S” to stand for size as the CANSLIM stock strategy assumes that it is easier for smaller companies to have significant growth spurts than larger ones. The reason for this is tied to the basic principles of supply and demand, which are the foundation of the market economy. Essentially, large-cap companies need more significant and substantial increases in demand to create the same increase in earnings as a smaller company – at least percentage-wise. Although large-cap companies will most likely have a larger increase in sales volume, the percentage of this increase tends to be lesser than smaller companies. Larger increases in earnings tend to translate into larger gains in stock prices, which is why CANSLIM stock strategy focuses more upon small-cap companies, but it still may consider large-cap companies that have substantial earnings growth.

It is also true that larger investors, such as pension funds and insurance companies, are more likely to buy long-term, stable investments. Therefore, it is natural for such large investors to gravitate towards large-cap investments. Such investors typically try to avoid excessive transaction fees, which explain why they tend to make large investments (as opposed to several smaller ones). Unless there is some run on the stock which saps supply, such large transactions may actually drive prices downward.

L = Leader or Loser

Investors in the stock market must be able to discern the market leaders from those pulling up the rear. Companies that manage to continually lead their industry typically have great returns, and are fundamentally sound. But, for those businesses towards the bottom of the market, investors are lucky to see even a modest return their on investment. So how does the CANSLIM stock strategy separate the leaders from the losers?

Investors can identify leaders from losers by looking at the Relative Price Strength (RPS). The relative price strength looks at companies over a given period of time and then ranks them from 1-99. A business with an RPS of 75 indicates that the stock of this company has outperformed 75% of the stocks in the market group. However, CANSLIM stock strategy does not recommend companies with an RPS of less than 70. In fact, a company with an RPS in the high 80′s to lower 90′s is preferred.

I = Institutional Sponsor

Every growing business needs the sponsorship of institutional investors in order to be taken seriously as a sound investment opportunity. For a company without such investors, the implication is that it is not good enough to be included in a portfolio put together by any one of the thousands of money managers on the prowl for the next great investment. The CANSLIM stock strategy takes this idea a step further and requires businesses to have a minimum of 3 institutional investors. However, too many institutional investors can be a problem as well. When this happens, the stock can potentially become more volatile in the event of a natural disaster or crisis, because institutional investors are apt to sell off. Since such investors tend to buy large chunks of stock at a time, too many sell-offs could send stock prices crashing. Therefore, CANSLIM stock strategy includes staying away from any company with more than 10 institutional investors.

M = Market Direction

The final part of the CANSLIM stock strategy is to analyze the overall direction of the market before deciding to make a purchase. Although CANSLIM is not truly a market timing strategy (where investors try to “beat the market” by buying stocks at their lowest and selling at their highest – at least in theory), it is important for investors to understand the basic environment of the stock market.

For instance, investors who buy in just before a bear market emerges can literally be wiped out if they are not careful. While the long-term prospects may be bright, short-term losses will likely add up quickly. It may be years, if ever, before the stock prices recover to where they were when the investment was initially made. While there are a host of programs on both television and the Internet to help investors gauge the health of the stock market, these programs do not necessarily keep up with CANSLIM stock strategy. CANSLIM stock strategists can get a feeling for the market simply by keeping an eye on the daily volume of stock trades.

Typically, when the market is expanding and prices are increasing, the daily volume will be lower as investors hold onto their stock in hopes that it will go even higher (and by doing so, keep the supply of outstanding shares off the market and help prices remain high). However, when a bear market emerges, stocks begin to contract, and stock prices begin to drop, people will sell off their stocks in an attempt to cut their losses. This causes the supply of outstanding shares to increase while demand is decreasing, resulting in lower prices. Therefore, investors should always decide if the market is trending up or down before committing to any stock purchase using the CANSLIM stock strategy.

Truthfully, no stock investment strategy will guarantee a profit. Although the CANSLIM stock strategy does require some personal judgment on the part of investors, it remains a highly structured, well-researched, and proven system. And, while there may be no guarantees, the CANSLIM stock strategy does remove the guesswork from choosing stock investments to a certain extent, and provides investors with a solid foundation from which to base future decisions.

This article was brought to you by the InvestorGuide Staff Writers and Editors.

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