The CAN SLIM model for selecting stocks was developed by William J. O’Neil, founder and chairman of Investor’s Business Daily. The system is described in his best-selling book, “How to Make Money in Stocks: A Winning System in Good Times and Bad” – now in its fourth edition. The goal of the strategy is to identify companies with strong fundamentals and buy them as they emerge from periods of price consolidation, before they make major price advances.
The Elements of CAN SLIM
The seven letters in the CAN SLIM acronym stand for the key traits O’Neil found that stocks display just before they make their biggest price gains. CAN SLIM combines both quantitative and qualitative stock assessment into one easy to remember mnemonic device, it is described below.
C = Current Quarterly Earnings
Substantial earnings-per-share growth can attract the large institutional players – something that can fuel big price moves. According to CAN SLIM, investors should look for companies with a minimum quarterly EPS growth of 25% in the most recent quarter – though gains of 50% to 100% are even more attractive. Of course, you want those gains to be sustainable, so the company should also have at least 20% sales growth in the most recent quarter and a minimum 17% return on equity.
A = Annual Earnings Growth
While good quarterly earnings are important, a company should also boast strong annual earnings growth. This can help confirm that the company doesn’t have any underlying problems, such as falling demand for its products, deteriorating profit margins or negative industry trends. CAN SLIM investors look for an annual EPS growth rate of at least 25% to 50% in each of the previous three to five years. Remember there is no good reason to hold a company’s stock if its earnings are declining. STOCKS FOLLOW EARNINGS!
C + A = QUANTITATIVE The first two parts of the CAN SLIM system – strong quarterly and annual earnings – are logical steps employing quantitative analysis.
N = New Product or Service
The third trait that CAN SLIM investors look for is something new in the company – whether that’s a new product, service, CEO or high stock price, or an innovative industry trend that benefits the company in some way. Wall Street is always on the prowl for the next best thing, whether that’s an entrepreneurial company disrupting an industry or an established company that reinvents itself by pivoting to new products. Something new can equate to profits for years to come, and sometimes decades.
Domino’s Pizza (DPZ) A perfect example of how newness can create success can be seen in Domino’s Pizza (DPZ). After gaining a reputation during the early 2000s as the worst pizza chain, Domino’s went through a major shift in late 2009. The company came out and blatantly acknowledged that its pizza was awful, and it was committed to upgrading the product. On top of rebranding, the company also looked to upgrade its mobile delivery system. With the implementation of these changes, Domino’s has seen its share price climb over 3300% since 2009. This is just one of many compelling examples of companies that – through doing or acquiring something new – achieved great things and rewarded their shareholders along the way.
S = Supply and Demand
The law of supply and demand governs all market activities: strong demand for a limited supply of available shares will drive price up, and an oversupply of shares coupled with weak demand will drive price down. CAN SLIM investors watch for sharp price increases backed by spikes in trading volume. These events indicate demand – especially from mutual fund managers and other institutional investors – that can lead to even bigger price moves.
L = Leader or Laggard
In any industry, there are companies that lead and provide big gains to shareholders, and companies that lag and deliver gains that are at best mediocre. The idea is to buy leaders and avoid laggards; CAN SLIM investors look at the relative price strength of a stock to differentiate between the two. A stock’s relative price strength ranges from one to 99; a rank of 75, for example, means the company has outperformed 75% of the stocks in its market group over a particular period of time. CAN SLIM investors look for stocks that have relative price strengths of at least 70 – though stocks in the 80 to 90 range are generally more likely to be the major gainers.
I = Institutional Sponsorship
This trait refers to whether the stock is owned by banks, mutual funds, pension funds and other institutional investors. Such ownership can be viewed as positive confirmation of a potential winner. Professional investors have teams of analysts who research thousands of potential investments. When one of them starts buying a stock you’re considering, it can increase demand for the stock – and potentially trigger rising share prices. CAN SLIM investors should focus on stocks that have at least three to 10 institutional owners.
M = Market Direction
The final trait in the CAN SLIM model is market direction. When picking stocks, it’s always important to recognize whether you are in a bull or bear market. CAN SLIM investors believe you should invest with the market, as opposed to against it. The theory here is that, according to CAN SLIM, three out of four stocks move in the same direction as the general market – as measured by the major indices (the NASDAQ Composite, the S&P 500 and the DJIA). If you buy a stock when the market is in an uptrend, the theory goes, you have a 75% chance of being right; conversely, you have a 75% chance of being wrong if you buy when the market is in a downtrend.