How to Make Money in Stocks

C-A-N-S-L-I-M

For many investors, the dream is to find a stock ready to shoot way up in price—maybe increase five or ten times in value within the next year or two. Of course we can find plenty of examples of stocks that have already done that, but the trick is to find them before they go up.

While investment gurus speak about technical and fundamental analysis, there are few who combine both to the best effect. One such method is C-A-N-S-L-I-M. William J. O'Neil, founder and publisher of Investor's Business Daily, a stock market newspaper, struck upon a system to give explosive increase in stock values using both tools.

How would you know that a particular stock is poised for an explosive increase in value? It turns out that William J. O'Neil pondered the same question. O'Neil, who has been in the business of providing stock market data to institutional investors since the 1960s, created a database containing fundamental and price information on thousands of public companies. Then he analyzed these winners to find the characteristics they had in common before they took off. O'Neil published the results of his study in a book called "How to Make Money in Stocks."

O'Neil believes he found the winning formula, the seven basic characteristics most stocks have before enormous price advances. He uses the C-A-N-S-L-I-M acronym to identify the necessary attributes. We present a synopsis of the book.

C = Current Quarterly Earnings

Start With Earnings Growth. Earnings growth is the key to the CANSLIM strategy. Look for companies with the largest increases in quarterly earnings compared to the same quarter last year. Bigger is better! Seventy-five per cent of the winners in O'Neil's study had quarterly earnings jumps of 70% or more. The minimum acceptable increase is 18%. One caveat though, avoid stocks with tiny year-ago earnings. Huge increases don't mean much if your comparing to a miniscule year ago number.

A = Annual Earnings

Consistent annual growth rates of 25% or more over the last four or five years are an important factor. Consistency is the key word. Make sure forecast earnings for next year are in line with the historical growth rate.

N = New Products or New Management, and new Highs

Look for a catalyst that will propel fast earnings growth, such as new products, inventions etc. Companies with blockbuster products are likely to propel company profits.

O'Neil also includes new highs in stock price here. He wants stocks at or near their all time highs. This is the hardest aspect of the strategy for most new investors to accept. Our natural tendency is to buy stocks after they have gone down in price—not when they are at new highs. His rationale is that stocks that have hit a new 52-week are doing so on the back of some fundamental changes and these stocks will go on to achieve new 52-week highs.

According to him, stocks that are hitting 52-week lows are languishing because of some good fundamental reason and investors should stay away from them.

S = Supply of Stock

Stock prices move as a result of supply and demand for the company's shares. If there's not many shares in circulation, a small amount of buying could push prices up quickly.

L = Leader

Here O'Neil is talking about stock price action, not a company's success in selling product. Look for stocks that have outperformed at least 80 per cent of the rest of the market during the past year.

The CANSLIM strategy requires you to only select companies in a strong industry group. That is, the stock prices of most companies in the same industry must be performing well. The company should have the best performing stock in its industry.

I = Institutional Ownership

Institutions are mutual funds, corporate pension plans, insurance companies, etc. O'Neil likes some, but not too much institutional ownership. Look for 5% to 25% institutional ownership. The reason is that when institutions dump a stocks there is generally a big fall, which could hurt your portfolio.

M= Market Direction

Very few stocks go up when the market is going down. Buy only when the market as a whole is going up. Those are the selection criteria. Once you've picked promising candidates, you have to decide when, if ever, to buy the stock. O'Neil looks at a stock's price chart for guidance. He looks for stocks that have been consolidating (bouncing around a limited range) for a while, and then move up to (or close to) new highs.