CANSLIM: How to Discover Great Stocks Before Everyone Else

Everyone always wishes they had known about Amazon and Walmart before their stock prices soared.  But trying to find such breakout stocks is like trying to find a needle in a haystack.  As they say, hindsight is 20/20.  And if we had known then what we know now, we'd all be rich.  

Though it may seem impossible to be able to pick the next Amazon, there may be a way to do so.  How you say?

With CANSLIM.

Although it may sound like a weight loss product, it is, actually, an investment strategy invented by Willian O'Neill, one of the founders of Investor's Business Daily.

CANSLIM is lays out seven points you should look for before deciding to buy a company's stock.  By using his method, you have a proven way to pick stocks with high growth potential. 

Everyone wants to buy a stock before it takes off.  Now, with this investment strategy, you just might find out how.

Let's take a look at how this works in detail so you can start implementing this strategy when you invest.

What is CANSLIM?

CANSLIM is an investment strategy invented by William J. O'Neill and popularized in his book, How to Make Money in Stocks. 

It is a stock picking strategy used by investors today to help them screen and analyze stocks.  By using this method, investors can minimize risks and maximize gains.

More specifically, CANSLIM is a growth stock investing strategy that will help you pick stocks that are poised for a substantial amount of growth.

But first, you have to make sure they tick all the boxes outlined in this investing strategy.

The company you are interested in must meet 7 criteria before it qualifies as a good company to invest in.  The name, CANSLIM, itself is an acronym and so it can help you remember each of these criteria.

C = Current Earnings

A = Annual Earnings

N = New

S = Supply & Demand

L = Leader or Laggard

I = Institutional Sponsorship

M = Market Direction

How to Use CANSLIM

Now it's time to start learning how you can start using this strategy to pick good up-and-coming stock.  Let's go through each of the criteria so you know what to look for and how to weed many companies out.

Current Earnings 

Of course, one of the first things you'll want to do when deciding which company to invest in is to look at its earnings.  More specifically, you'll want to look at its earnings growth.

So take a look at its current earnings and compare them to the previous years earnings during the same quarter.  Here you will want to see at least an 18-20% growth.   

Some even say, it should be at least 25%.  But, just so you know, the really great ones will have 50% or more.  You'll find these values listed as the EPS, or Earnings per Share.

The one tricky part here is making sure they are good, quality earnings. Some companies use accounting tricks to make their earnings look better than it actually is.  While others earnings may appear rosier because of a one-hit-wonder.

So when you are doing your earnings check, make sure you determine the quality of those earnings as well.  You may also want to check the earnings growth in the industry as a whole to see if it's thriving or on its way out.

Plus, a little peak at the company's ROE (Return on Equity) wouldn't hurt as it tells you how efficient the company is using its assets.  And that should be over 17%.

Annual Earnings

Like with the current earnings criteria, you are going to want to see here some good earnings growth.  In this case, a year-on-year growth of at least 25% for the past 5 years.  Strategist say between 25%-50% is the sweet spot.

New

As you could probably guess, the "new" here refers to a new product, idea, or service the company has in the offing.  It can also refer to anything new relating to the company that can bring about significant change in the right direction.

This includes new management or entering a new market.  Some might also say that new stock price highs can fulfill this criteria as well.

Supply and Demand

The governing rule of any market is always supply and demand.  For if a product is in high demand, but the supply is low, the price will be high.  If a product is not popular and the supply is high, the price will be low.

And so it is with stocks.  O'Neill found in his study of stock market winners that smaller cap companies or those with fewer shares outstanding than large cap companies showed the greatest gains (all else being equal).

That is because larger companies need much more demand for their products than smaller companies to produce the same gains.  And according to his study, the companies with the greatest gains had less than 25 million shares.

You may also want to take a look at a stock's trading volume for some real-time demand of the stock itself.  And, while you're at it, check out whether the company has been buying back its stock.

This not only decreases the supply of stocks out there but also tells you that the company's leaders are confident in the company's future.

Leaders or Laggards

Is the company you are interested in a leader in their industry or a laggard? If I were a betting woman, I'd say you'd probably want to invest in a company that is leading the industry, not struggling to keep up.

To find out if your company is a leader in its industry, you need to look at the Relative Price Strength (RS) Rating of the stock.  It measures the stocks price performance for the last 12 months and ranges from 1 to 99.

The RS rating show you how the price of a stock compares to all other stock prices.  According to CANSLIM standards, you want a company with a relative price strength of at least 70, meaning it is outperforming 70% of all stocks.  

However, O'Neill says the bigger winners are usually in the 80-90 range.

Institutional Sponsorship

One of the unique points about the CANSLIM investing strategy is that it takes into account the movement of large institutions and their affects on stock prices.

If a majority of the stock is owned by large institutional investors, that may be a stock you want to avoid.  

Why?

Because any bad news about the company, its products, or its employees could send the stock plummeting in no time.  To check out the stats for this, take a look at the Accumulation/Distribution ratings which gives you the rundown on institutional buying and selling over the past 12 months.

That being said, institutional involvement isn't all bad.  After all, if the company is not sponsored by any bank, mutual funds, or large institutions, then they might not be worth investing in yourself.

The CANSLIM strategy calls for at least 3 - 10 institutional owners in a company.  But, remember, all institutions are not created equal so be sure your company has quality institutional sponsorship.

So look for funds with excellent managers that have outperformed the market for at least the last 3 years.

Market Direction

It is said that 3 out of 4 stocks go with the market.  So, knowing whether the market is going up or down will determine whether you should buy or not.  

Because CANSLIM is a growth stock market strategy, it is best used when the market is going up.  Otherwise, you may buy a stock at one of the best companies only to have it still go down with the market.

So before you buy, you must determine in which direction the market is heading.  Up? or Down?

Use the S&P 500, the Dow, and the NASDAQ indexes to see which way the market is trending.  Check the trading volumes and overall movement of the market daily.

For this criteria, you may have to do some technical analysis, which uses patterns in market data to see trends and make predictions.  That way, you can figure out in which direction the market is heading.  

The Pros of Using CANSLIM

The beauty of the CANSLIM method is that it incorporates value investing, fundamental analysis, technical analysis, and growth investing all in one. Giving you a pretty strong foundation for picking a great company.  

And what could be better than that!?

Furthermore, its guidelines on what classifies as a worthwhile investment are very specific and easy to follow.  So this investing strategy is very hard to mess up.

Another plus for using CANSLIM is that there is no defined time for how long you need to hold the stocks purchased using this strategy.  You can hold it for 10 years or just a few weeks.  The only thing they suggest is cutting your loses at 7% or 8%.

You can do this by using a stop-loss order.

The Cons of Using CANSLIM

One of the problems with CANSLIM is that it is a bit risky.  After all, with CANSLIM you are playing with the big boys.  And by big boys, I mean the big financial institutions.

These boys have been at it for a while and are pretty good at picking winners early.  The trick that you have to master is getting in before most of these big players do.  

Otherwise, you run the risk of missing that big upswing you were hoping for when you got in it.

Not to mention, the growth stocks can lose their value really fast if market directions shifts.  In which case, the big institutional investors may pull out and send the stock's price spiraling down.  And you could end up losing lots of money. 

So, CANSLIM definitely has a learning curve.  And it may just be for those investor's with a high risk tolerance and those with enough experience to  properly assess companies and the market.

All in All

The CANSLIM method offers an easy-to-follow formula for investors who wish to get in on a hot company before its price soars.  

However, this method also comes with its own risks that you must be aware of.  So be sure to take that into account as you decide whether this investment strategy is for you.

And if you are worried about having to check all these criteria yourself, never fear there are institutions that have already done that for you!  Just look for their CANSLIM mutual fund or ETF.

Happy Investing!