Investing can be extremely psychologically demanding.
Not only are you up against the world’s best investors, but you’re also up against yourself. It’s easy to get caught making irrational decisions based on your own personal blindspots or cognitive biases, and these mistakes can lead to buying when you should sell, and vice versa.
For the above reasons, the most successful investors are often those that have rational and proven systems in place.
Having a method to your madness allows you to have confidence in your decisions, while also taking advantage of the strategies and heuristics that have performed well for the world’s most elite investors.
HOW TO PICK GROWTH STOCKS
Today’s infographic comes to us from Investor’s Business Daily, and it details the basics around the discipline of growth investing, including the differences the school has with value investing.
More importantly, it also provides a framework for choosing growth stocks used by elite investors such as William J. O’Neil.
Growth investing is all about identifying the companies that are exhibiting behavior that suggests that they will be tomorrow’s leaders.
The benefits to this strategy, if successful, are easy to see. Think about buying Microsoft before it dominated the software industry, or Starbucks before it conquered the United States with its new approach to coffee culture.
The question is: how can these stocks be found reliably?
THE CAN SLIM APPROACH
Fantastic growth stocks don’t just grow on trees – instead, you have to have a system to sift through them.
One easy place to start your search for the next growth leader is with an approach pioneered with investing legend William J. O’Neil. Developed in the 1950s, the CAN SLIM strategy identifies seven characteristics that top-performing stocks often share before making their biggest price gains.
Each characteristic is represented by a letter in the CAN SLIM acronym:
C – Current quarterly earnings
A – Annual earnings growth
N – New product, service, management, or price high
S – Supply and demand
L – Leader or laggard
I – Institutional sponsorship
M – Market direction
Importantly, each of these traits can be a catalyst to influence other traits. When they compound, it can lead to big price movements that beat the rest of the market.
BREAKING DOWN THE FACTORS
Let’s look at each characteristic of the CAN SLIM approach in more detail:
Current quarterly earnings
Look for companies with a minimum earnings-per share (EPS) growth of 25% in the most recent quarter, though 50% or higher is even better. These companies should also have 20% sales growth in the quarter, and a 17% ROE to ensure that growth is sustainable.
Annual earnings growth
Look for companies with annual EPS growth of at least 25% to 50% in each of the previous 3-5 years. This helps confirm that the company is showing long-term growth.
New product, service, management, or price high
What is the company doing that is new or game-changing? To be a market winner, a company must constantly reinvent itself to position itself for higher-than-average profits.
Examples: Consider Google’s monetization of search ads, or McDonald’s novel approach to food. These innovations set the companies up for massive profits and success.
Supply and demand
A stock price increases when more investors demand an increasingly limited supply of shares. Spikes in price, along with volume accumulation, mean that demand is increasing. If this is coming from institutional investors, who tend to buy and hold, it’s even better.
Leader or laggard
The leading companies in leading industries – the best of the best – will be the companies that have the most growth potential.
75% of all market activity comes from professional investors, such as mutual funds or pension funds. Not only does the smart money help validate a potential growth stock by being involved, but they can trigger big price increases.
CAN SLIM investors believe you should invest with the market, as opposed to against it. That’s because an individual stock moves with the market 75% of the time.
PUTTING IT TOGETHER
Understanding how the different CAN SLIM factors work together – and how they can help bring massive bouts of growth for the underlying stock – is key for the successful growth investor.
Using a rational system like this also helps you in overcoming cognitive biases or making other mistakes that may affect your investments, as well.