We all are interested in knowing the common characteristics and rules of success related to picking winners in stocks. There have been many intensive studies of past market leaders to identify patterns and develop investment strategies.
One such winning system which seems to have worked across different market cycles is CANSLIM.
CANSLIM stands for one of the seven chief characteristics of identifying winning stocks at their early developing stages.
Lets look at the seven main dimensions of CANSLIM.
- C Current Quarterly Earnings and Sales : The higher , the better
- A Annual Earnings Increase : Look for Significant Growth
- N New Products, New Management, New Highs : Buying at the Right Time
- S Supply and Demand: Shares Outstanding Plus Big Volume Demand
- L Leader or Laggard : Which is your Stock?
- I Institutional Sponsorship : Follow the Leaders
- M Market Direction : How you can Learn to Determine it.
Lets look at key points for each of the dimension
Seven Dimensions of CANSLIM
C = Current Big or Accelerating Quarterly Earnings and Sales per Share
The stocks you select should show a major percentage increase in current quarterly earnings per share when compared to the prior year’s same quarter.
Buy stocks showing huge current earning increases. You should always compare a company’s earnings per share to the same quarter a year earlier, not the prior quarter, to avoid any distortion resulting from seasonality. This also means that one time extraordinary gains of a company should be omitted.
Its important to insist on both sales growth as well as earnings growth.
Its also very important conversely to know when earnings begin to decelerate or slow down significantly. Even the best companies can have a slow quarter once in a while, its good to see two consecutive quarters of material slowdown.
Logarithmic scale graphs are very useful in analyzing stocks because they can clearly show acceleration or deceleration in the percentage rate of quarterly earnings increases.
A= Annual Earnings Increases : Look for Big Growth
Buy stocks with proven records of significant sales and earnings growth in each of the last three years plus strong recent quarterly improvements and a high return on equity (ROE).
Its important to combine these fundamental indicator with good chart patterns . Don’t expect anything less so that we achieve better results.
N = Newer Companies, Newer Products, New Management, New Highs off Properly Formed Chart Bases
We need to look for companies that have developed important new products or services, or that have benefited from new management or materially improved industry conditions. Then buy their stocks when they are emerging from sound, correctly analyzed price consolidation patterns and are close to or actually making, new price highs on increased volumes.
The greatest paradox in Stock Market
What seems to be high in price and risky to the majority usually goes higher eventually, and what seems low and cheap usually goes lower.
S= Supply and Demand : Big Volume Demand at Key Points
The price of almost everything in daily life is determined by the law of supply and demand.
Daily trading volume is the best way to measure a stocks’ supply and demand . This is very important! When a stocks pulls back in price, we typically want to see volume dry up at some point, indicating there is no further selling pressure.
When the stock rallies in price, in most situations we want to see volume rise, which usually represents buying by institutions, not the public.
Apart from this , we should buy companies decreasing their debt as a percentage of equity (D/E). Last 2-3 years of numbers are worth considering. Another thing to watch for is the presence of convertible bonds in the capital structure; earnings could be diluted if and when the bonds are converted into shares of common stock.
Companies buying back their stock in the market and showing good stock ownership by management are preferred.
L = Leader or Laggard : Which is your stock?
It seldom pays to invest in laggard stocks, even if they look very cheap. We should look and confine our purchases to market leaders. Get out of laggard losers if you’re down 8% below the purchase price so that you won’t risk getting badly hurt.
Market corrections are very helpful to identify the new market leaders. The more desirable growth stocks normally correct 1.5 to 2.5 times the general market averages. In a bull market correction , the growth stocks that decline the least are usually your best selections.
I = Institutional Sponsorship
It takes big demand to push up prices, and by far the biggest source of demand for stocks is institutional investors such as mutual funds, pension funds, hedge funds, insurance companies etc.
Buy only those stocks that have at-least a few institutional sponsors with better than average recent performance records and have added institutional owners in recent quarters.
Institutional Sponsorship means market liquidity that provides buying support when you want to sell your investment.
M = Market Direction
We can be right on every one of the factors in the previous 6 characteristics , but if we’re wrong about general market direction , and that direction is down, 3 out of 4 stocks will plummet along with the market averages and you will lose your money big time, as many people did in 2000 and again in 2008