The CAN SLIM investing strategy is a comprehensive stock selection system, and is one of my personal favorites. CAN SLIM is an acronym that represents each step William O`Neil developed to identify stocks that have the same characteristics as past market winners. Thus, this method utilizes a seven step process in the effort to find the best stocks in the market.
The CAN SLIM investment strategy is geared towards finding growth stocks. Growth stocks tend to outperform the market and are considered to be higher than average risk investments. However, where there is more risk, there is more reward. This is in contrast to other stock screening methods such as value and momentum investment strategy. The CAN SLIM stock screening methodology utilizes the following criteria.
"C" Current Earnings
The first step in the CAN SLIM screening process involves the analysis of a stock's current earnings. The investing strategy uses a floor of 25% quarterly earnings growth. This means that screen will filter out any companies with less than 25% quarterly earnings growth.
Why is earning growth important? Simply stated, the more a company earns, the more a company is worth. If the Company's earnings are increasing rapidly, their sales are probably increasing as well. This is an indication that a company is outperforming it's competition and who's stock will most likely outperform the market.
"A" Annual Earnings
The second step in the screening process seeks to ensure that the Company's earnings growth is not a short-term trend. When limiting your analysis to a Company's quarterly earnings, the trend can be deceiving. This is due to a variety of business decisions that can affect the appearance of earnings in the short-term (such as temporary cost reductions). To avoid being duped by a short-lived earnings pop, O'Neil included annual earnings growth as an important investment selection criteria.
So keep in mind when searching for stocks with the potential to outperform, annual earnings growth of at least 25% is important. Bottom line, this is a long-term earning growth screening criteria that seeks to eliminate companies that do not have sustainable earning growth greater than 25%.
"N" New Product or Service
The third criteria when evaluating investment opportunities with the CAN SLIM strategy seeks to find companies that have a high probability of succeeding in the future. It should be noted that the first two criteria (earnings growth) in the CAN SLIM investing system are easily obtained and measured, this third one is a little squishy (to use a technical term).
As an stock investor or trader, you should be forward looking. Meaning that the stocks you buy today should have something that makes it stand out in the future. This can be the brand new and innovative product, technology or service.
Some investors decided to use a stock hitting a "new high" as satisfying this criteria as its easier to measure and eliminates the need for a subjective assessment. At the minimum, avoid buying stock in a Company whom is clinging on to old technology, outdated products or business practices.
"S" Supply and Demand
Ultimately, the price of a stock is determined by supply and demand. If there is greater demand for a stock then there is supply, the stock's price increases. Inversely, if there is greater supply of a stock then there is demand, the share price falls. It's interesting how these basic principals of microeconomics (and human emotion) drive the markets.
With that said, stocks under accumulation are in demand (we want to own stocks that are in demand). This criteria is usually measured through analyzing stock trading volume. When assessing trading volume look for increasing trends and large spikes (greater than average) in buy volume. This indicates that the demand for the Company's stock is increasing.
"L" Leader or Laggard
The next (and fifth) step in the CAN SLIM investing system seeks to identify stocks that are market leaders. This investment strategy leverages a measure called Relative Strength (RS), which is used to determine if a stock outperforming or under-performing the market as a whole.
The CAN SLIM investing system utilizes a 1 - 99 point rating scale to rate a stock's relative performance over a 12 month period. As an example, if a stock is rated with a RS of 90, this indicates that it is outperforming 90% of the market.
Logic would lead you to believe that buying a stock with a rating in the high 90s would be the best choice. However, remember that once stocks have had a good run higher, they pull back and go through price consolidation for a period of time. Thus, it is a best practice to look for stocks in the RS range of 80-90.
"I" Institutional Sponsorship
In the stock market there are "heavy hitters" that are referred to as institutional investors. These large organizations (i.e. pension, mutual, hedge funds) have trillions of dollars in assets. When these institutions begin buying a particular stock, they have the ability to make the prices move for a long time. This is why the sixth criteria in the CAN SLIM investing strategy seeks to ensure that the stock has institutional sponsorship.
Institutional sponsorship can be measured in a few ways. The most popular being increasing or spiking volume (accumulation), however an investor can also sort through the institution's investment documents. When institutions begin to buy a stock, they do so overtime. When spacing out their purchases (think millions of shares), these institutions are trying not to drive the price of the stock out of their preferred buy range.
"M" Market Direction
The last step, which in my opinion should be the first, ensures that the investor is cognizant of the market's general direction. This also includes understanding of any potential macroeconomic threat that could have an negative affect on the financial markets.
There is a saying that describes the correlation between the different asset classes in the market, a "rising tide lifts all ships". This adage illustrates the point that if you are in a bull market, most stocks will rise with the tide. On the other hand, if the tide is moving out, then it will most likely lower all stocks. This is regardless of how well the individual stock is performing.