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What Is CANSLIM and How to Use It?

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by Oluwapelumi Adejumo · 8 min read
What Is CANSLIM and How to Use It?
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The guide explains the basics of the CANSLIM strategy. Investors can utilize it to accurately identify stocks with high growth potentials. The strategy has been able to out-perform the benchmark averages both in the short term and in the long term.

CANSLIM is a bull market trading strategy for identifying stocks that have high growth potential. This system utilizes seven different yardsticks to select stocks. Each yardstick is represented by one of the letters in the strategy’s name. CANSLIM also factors in trading rules to attempt to buy stocks prior to a big run-up while simultaneously cutting down losses.

The objective of CANSLIM is to help traders in their search for stocks with the potential to outperform the overall market as well as other stocks in the industry. In terms of implementation, the strategy is the best in the fast-moving markets. It allows to make money in stocks when the market has an upward growth. This is in contrast to the bearish approach adopted by other stock traders who believe the prices of stocks will eventually drop.

History and Creators of CANSLIM

The CANSLIM strategy was developed by William J. O’Neil born in 1933. He started working at Hayden, Stone & Co. as a stockbroker after graduating with a business degree from Southern Methodist University. O’Neil started using CANSLIM, his trading strategy, to pick stocks. Notably, it has remained essentially the same ever since its introduction.

After five years at Hayden, Stone & Co., William J. O’Neil began to diversify into other ventures and founded William O’Neil & Co. in 1963. The firm based its activity on CANSLIM’s approach and was successful since its inception.

In addition to that, O’Neil’s firm was the first to create a computerized database of daily security information that monitors about 7,000 firms globally. William O’Neil sold the research accumulated from its database to various institutional investors.

CANSLIM Breakdown

Let us have a deeper look at the components of the strategy.

  • C – Current Earnings

From a series of research, William O’Neil found out that a lot of the companies that experienced strong stock price growth had quarterly earnings growth that exceeded 70 percent prior to the price growth. This is often the case for a very small number of highly successful companies. To build a portfolio of stocks or have at least a variety of choices to pick from, O’Neil recommended a more recent quarterly (MRQ) earnings per share (EPS) increase of a minimum of 18-20 percent. He also recommended a sales growth of at least 25 percent. Sales growth is necessary because without consistent sales growth, maintaining growth earnings would be a difficult task.

  • A – Annual Growth

In this regard, William O’Neil suggests an annual growth rate in earnings of at least 25 percent. Besides, a return on equity (ROE) of above 17 percent should be checked for as it is an indication that the firm is efficiently investing its capital. A lot of stock screeners will permit the filtering of 1,3 and 5-year annual earning growth. Picking a 5-year annual growth earning will help you to filter out those firms experiencing short-term growth or those manipulating their accounts to indicate higher earnings per a certain quarter.

  • N – New Products, Managements, or Price Highs

If a particular company has a reputation for being innovative or known to develop products that are superior, in terms of quality, price, or both, to the ones in the market, this is a good indication for future stock price growth. Management or board change as a result of the introduction of new people into the organization’s leadership is a positive indicator because new people mean new ideas. However, it should be noted that this doesn’t always work. What is known though is the fact that new price highs may encourage the demand for the stock. As a result, the price will further increase.

  • S – Supply and Demand

If the supply of a seller outweighs the demand of the buyer, there will be a reduction in the price of stocks. If the opposite happens, the price will begin to rise. On any given day, there may be situations where the prices of stock will either go up or down. But such days are mostly not important. In situations where you experience weeks or months of volume growth and the price of stocks increases, you should know that demand is higher than supply. In such situations, William O’Neil advised that the daily trading volume needs to be higher than the average volume for stock in the previous months.

  • L – Leaders

There is a competitive edge for a company leading in a certain industry in terms of product or service quality, or pricing. However, it is a difficult task to sift through different companies by going through their price listing and do a competitive market analysis. To solve this dilemma, CANSLIM suggests that looking for companies with stock price strength greater than their rivals, or 80 percent higher than those in the stock market is the most ideal choice. What this means is that you have to select the companies that are already ahead of the market.

  • I – Institutional Ownership

A whopping 70 percent or more of all the shares are owned by institutions, mostly on behalf of investors. In a situation where you own a pension, you do not own the stock in reality. Instead, you own part of the company that holds those stocks. In this situation, it is ideal that you would want to see a minimum of 30 percent institutional ownership. It will convey to you that the company is within the radar of institutional buyers. Investment companies are better positioned to make the most significant impact on stock prices owing to their purchasing power. If the company is not attractive enough for the investing firms, the probability of the stock price increasing is negligible.

  • M – Market Direction

With a good understanding of the market direction, you will be able to time your purchase of stock. The market moves in an uptrend, downtrend, or consolidation (sideways) directions. There will be a minimal chance of making money if you are buying stocks during a multi-year bear market. During the period of market fear, there is a drop in price of most company’s stock.

According to O’Neil, 3 out of 4 stocks move in a similar direction as the market. What this means is that 3 out of 4 stocks in the market tend to move upwards as the market is the only reflection of all the stock prices. So when you buy stocks in a bull market, the probability of making profit is high.

CANSLIM Trading Rules

The major advantage of the CANSLIM strategy is that it is far more accessible in comparison to many other trading strategies. In order to make a decision as to whether a stock is worth investing in, a trader needs only to check if the stock meets the seven CANSLIM criteria and also ensure that the security meets each of them.

In summary, CANSLIM trading rules includes:

  • Reduction of all losses to 8 percent;
  • Taking your profits slowly;
  • Averaging up and not down;
  • Purchasing at bases.

How to Use CANSLIM

Looking at the seven CANSLIM criteria, it is clear that you should only use the strategy in a bullish market. Besides, experienced investors should use it as stocks that meet the CANSLIM criteria are usually the quickest ones when market direction tilts and sentiment becomes bearish.

The major concern for investors when choosing an investment-worthy stock is its price. They tend to prioritize cheap stocks that are identified by low price-to-earnings (PE) ratio over those with high PE. Investors looking to buy stocks shouldn’t only rely on PEs of stocks. They should also consider high quality businesses that have sustainable competitive advantage even if their stocks are not cheap. CANSLIM is effective in identifying such businesses.

With the strategy, investors not only have the needed assistance in picking stocks with a greater chance of appreciation, they now have a strategy that can help them limit losses in situations where the company takes a turn for the worse.

CANSLIM can also help investors to make informed decisions as to when to sell their stocks to make profits. In situations where the stock is still being acquired by institutional investors, there is the chance that it would take an upward turn. Then, investors are should hold it for a minimum of eight weeks. However, for those stocks that haven’t experienced a sudden spike, the sell sign will include trade volumes dropping below the 50-day moving average. It translates into an institutional selloff, a negative sign that may affect the future growth of a company.

Conclusion

The CANSLIM strategy is an important one. Investors can utilize it to accurately identify stocks with high growth potentials. The strategy has been able to out-perform the benchmark averages both in the short term and in the long term.

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