William J. O’Neal is one of the greatest investment strategists of our time. Mr. O’Neal started his career as a stockbroker with Hayden, Stone & Company in 1958, and developed an investment strategy (CANSLIM), which made him the highest performing broker in his firm. At 30 years of age, Mr. O’Neal became the youngest person to buy a seat on the Ney York stock exchange. In 1983, Mr. O’Neal founded what is now known as the Investor’s Business Daily newspaper (IBD).
The CANSLIM investment strategy is a stock picking method that seeks out growth stocks that have “the greatest potential for swift price rises from the moment they are purchased.” The American Association of Individual Investors (AAII) conducted a study of 50 top investing strategies from January 1, 1998 through December 31, 2009 and found CANSLIM to be the top performing investment strategy. Another AAII study found that from 1998 through 2009 the CANSLIM strategy produced a 35.3% annual investment return.
The CANSLIM strategy is a seven step investment strategy that is detailed in Mr. O’Neal’s bestselling book “How to Make Money in Stocks”. According to the CANSLIM method, these are the seven factors that an investor should look for when purchasing stocks:
Step One “C”
C = Current Big or Accelerating Quarterly Earnings and Sales per share. Look for growing earnings. A common characteristic of stocks that broke out to be big winners is that their earnings per share increased by a large percentage in the quarter or two before their major price advance. Blockbuster winning stocks such as Dell, Google and Apple all shared this characteristic. In IBD’s model of the best performing stocks three out of four showed earnings per share increases averaging more than 70% before they made their major advances.
Step two “A”
A = Annual earnings increases: Look for consistent annual earnings growth. We have already shown that quarterly earnings are critical in picking winning stocks. However, one should also look at annual earnings to make sure that the quarterly earnings numbers are not just an anomaly. The annual rate of earnings growth for the company that you select should be 25%, 50% 100% or more. IBD’s study of top performing companies found that the median annual growth rate of stocks in their breakout stage was 36%.
Step Three “N”
N = New : Look for newer companies, new products, new management, it almost always takes a catalyst which is provided by something new to produce major increase in the price of a stock. A new product such as Apple’s iPhone could fuel earnings growth. A new management team can signal a change in a company’s direction. A new need for a product or supply shortage can also cause a stock’s price to gap higher.
Step Four “S”
S = Supply and demand: Big volume demand at key points. It is obviously harder to move the shares of a stock that has 5 billion shares outstanding than a stock with 1 billion shares outstanding. Therefore, when all factors are equal the stock with the fewest outstanding shares will perform best. It is a good idea to look for the number of shares that are available after subtracting the amount of shares that are closely held by management. If management holds lots of shares it shows that they have confidence in the stock’s future performance. Additionally, if a company is repurchasing shares of its stock that indicates that management believes that the share price will move higher. The Yahoo Finance website provides this type of statistical information.
Step Five “L”
L = Leaders or Laggards: Which is your stock. The top one, two or three stocks in a growing industry can have unbelievable growth while others in the industry may remain flat. It is almost always best to buy best of breed stocks in top market sectors. Mr. O’Neal advice is to buy number one. He goes on to say “I don’t mean the largest company or the one with the most recognized name. I mean the one with the best quarterly and annual earnings growth, the highest return on equity, the widest profit margin, the strongest sales growth, and the most dynamic stock-price action. This type of company will also have a unique and superior product or service and be gaining market share from its older, less-innovative competitors.” Key statistical data can be found on the Yahoo finance website.
Step Six “I”
I = Institutional Leadership: It takes big demand to push up stock prices, and that is why you should seek to buy stocks with several institutional sponsors. The biggest sources of demand comes from institutional investors such as Mutual funds, pension funds, hedge funds, insurance companies, state, charitable and educational institutions. Individual investors cannot produce enough volume to significantly move stock prices, but institutional investors can. Without institutional backing, a stock’s price is not likely to rally. A good investor will check to see how many institutional investors a company has and then check to see if its institutional sponsorship is going up or down. Increasing institutional sponsorship could be a sign that the stock is picking up momentum. The quarterly trend in institutional ownership can be found on the Yahoo finance website.
Step 7 “M”
M = Market direction: The importance of determining market direction: Mr. O’Neal has found that even if you follow each of the six steps that were detailed above, you will lose money if the market direction is headed down. If the market direction is sloping downwards, it is probable that three out of four your stock picks will also go down. If you learn how to successfully analyze market trends you should never again find that your portfolio is down 30% to 50% in a bear market.
The main points to be learned from Mr. O’Neal’s CANSLIM method of stock investing is that you should buy stocks in companies with consistent and fast growing earnings. Look for best of breed stocks in top market sectors. Do not buy stocks whose prices have been trending downwards. Cut your losses! Remember that even the best investors make bad stock picks. Do not be too proud to admit you made a mistake. Limit your losses to 7% or 8%.
This article has only touched on the basics of the CANSLIM investing strategy. The book “How to Make Money in Stocks” gives in depth details about how to implement the strategy.