No, CANSLIM is not an acronym for yet another government program to help the banking industry or stimulate growth in some exotic way. It is a very specific and detailed investing strategy stgeloped by American Investor, William O’Neill.
O’Neil’s book – How to Make Money in Stocks: A Winning System In Good Times or Bad -describes his system, based on his research of 500 of the best performing shares dating back to 1953. Intelligent investors know that to win in the complicated game of share market investing, extensive reading is essential. This book would be well worth your time.
What makes CANSLIM especially appropriate for volatile markets is the application of strict investing rules, most notably its stop/loss provision. To qualify as a true strategy, an investing approach needs to do more than help you determine what to buy. These are stock-picking strategies, not investing strategies. A real investing strategy offers standards or rules for holding shares and selling shares.
CANSLIM has rules for holding and selling shares, the first of which is the most controversial – sell your shares if the price drops 8% or more below your purchase price. While some investors find this unrealistic, it has proven to be an effective way to minimize losses, especially in volatile markets. Even renowned value investor Warren Buffet says the first rule of investing is don’t lose money. The second rule is don’t forget the first rule.
Like many investing strategies, CANSLIM combines bits and pieces of several strategies. In its entirety, however, it is a growth strategy aimed at identifying companies with explosive growth potential before the explosion. Here are the seven major components of the CANSLIM investing strategy.
1. C – Current Earnings Per Share
2. A – Annual Earnings
3. N – New Product or Service
4. S – Supply and Demand
5. L – Leader or Laggard
6. I – Institutional Sponsorship
7. M – Market Indexes
Current Earnings per Share
This principle is based on research that indicates earnings growth is the single best predictor of large share price gains over time. The rule here is 25 per cent earnings per share growth in last quarter reported. This system recognizes reported earnings can be manipulated and stresses the need to distinguish between low quality earnings and high quality earnings. Accounting tricks, such as shifting expense reporting to a different period and premature revenue recognition, are signs of low quality earnings.
Finally, investors should consider the previous quarters in the fiscal year as well as the earnings growth in the industry sector as a whole.
To make the target list of a CANSLIM investor, a company should have 25 to 50 per cent earnings growth each year, for the previous 5 years. This standard is in concept similar to value investing, where your aim is to buy into a solid and growing business, not to make a few dollars here and there by momentum-trading shares.
New Product or Service
For this criterion, think change. Significant change is not restricted to introduction of a new and improved product or a revolutionary new service. Changes in the way a company does business often qualify as something new.
Apple computer changed its business model to incorporate applying its technological expertise to consumer entertainment. The iPod sent the shares on a non-stop climb that continues to this day.
New highs in share price are another potential buy signal. Most investors fear new highs, since so many shares trade down after reaching a new high. However, in his book, O’Neill presents compelling evidence that if the other CANSLIM standards have been met, new highs can signal a breakout to even more gains.
Supply and Demand
This standard follows the Peter Lynch principle that big companies don’t make big gains. They don’t because they are fighting the basic laws of supply and demand. Share prices rise when demand for the shares goes up. Small cap shares have less supply of shares than large caps. Check the ASX trading volume and you will see for yourself the huge share buys needed to push up the price of a large cap share.
Small caps, on the other hand, have the potential for much larger gains. A series of 1,000 share purchases can affect the share price of a small cap much more than the same series or buys have on a large cap. CANSLIM looks for companies with less than 25 million shares outstanding.
Leader or Laggard
This standard can be somewhat subjective, as it calls for looking for leadership companies in leading industries. While it is easier to spot a laggard, how does an intelligent investor differentiate the leaders?
There is a technical indicator, called the Relative Price Strength Rating (RPSR), which can help. The RPSR compares the price performance of a company’s shares against the performance of some market index for the same time period. As an example, one could compare the price performance of Australian energy company Oil Shares Limited to the performance of the XEJ – the ASX energy sector index – over the last twelve months.
Many investing strategies recognise the importance of institutional ownership. Vanity aside, it is safer investing in shares that are attracting fund investment than it is in discovering a spectacular share few in Australia have ever heard of.
However, it is always possible to have too much of a good thing, so CANSLIM sticks with shares of companies having anywhere from 3 to 10 institutional investors. As you know, markets can be headline driven. Shares with too many institutional investors rushing for the exits at the same time will suffer far more than those with only a few such investors.
Finally, CANSLIM recognises not all institutional money is equal. Some firms have better performance records than others. Investment houses with an excellent return for their clients are the ones you want to see as institutional owners in a CANSLIM target share.
In his examination of the top performing shares, O’Neil claims he found three out of four shares follow general market trends. This standard calls for some technical analysis tools to spot trends, but the core idea here is to invest in the direction of the market.
So there you have a basic introduction to the CANSLIM investing strategy. Next week we will continue looking at CANSLIM, focusing on some academic research that suggests it really works!