Mixing It Up: Technicals + Fundamentals = Consistent Winners (CAN SLIM)

Can Slim Strategy

A method of picking stocks promoted by William J O’Neil, who started Investor’s Business Daily, a competitor of The Wall Street Journal.

CAN SLIM is an acronym for the elements O’Neil looks at before deciding to buy.

C – Current earnings. Stocks that satisfy the CAN SLIM formula have unusually large increases in current earnings, usually 25 percent or more.

 A – Annual earnings. The annual earnings per share should show a growth rate exceeding 25 percent over the past five years.

N – New Highs. O’Neil suggests buying stocks that are making new highs after breaking out of a period of consolidation.

S – Shares outstanding. Stocks meeting the CAN SLIM formula have less than 30 million shares outstanding, with preferential treatment given to those with less than 5 million outstanding. Pay special attention to those that show big increases in recent daily trading volume.

L – Leading stocks, meaning stocks should be selected from the leading companies in the strongest industries. Attention should be paid to the relative strength of both the stock and the group in which it is in.

I – Institutional ownership. At least one large institution should be owners or buyers of the stock.

M – Market conditions. In the CAN SLIM formula, knowing the overall directional trend of the market is as important as the stocks you select. O’Neil recommends watching the 200-day moving average of the Dow Jones industrial average as well as changes in the daily volume.

Dan Zanger is a firm believer in the CANSLIM strategy, as this magic formula contains almost everything he needs to know about a company before buying it. In addition to the CANSLIM formula, Zanger has added some of his own criteria, and, interestingly, he has discovered over the years that stocks demonstrating interesting chart patterns on volume very often turn out to fulfill most if not all of the CANSLIM criteria. Here, again, is a summary of the CANSLIM criteria, including the way Zanger uses them.

C = Current Quarterly Earnings/Share Growth – For Zanger, this must be up a minimum of 40% and quarterly sales accelerating at 40% or better. (In the book, O’Neil recommends, “earnings must be up 18 – 20%, the higher the better.” Zanger requires double this as a minimum.) O’Neil also recommends that quarterly sales be accelerating or up 25%. As well, Zanger looks for companies with both earnings and revenuesthat demonstrate a continual quarter-over-quarter sequential expansion, known as “ramping up.” In retailers, however, he looks for year-over-year expansion (due to the seasonal volatility of the industry).

A = Annual Earnings Growth – Studies by O’Neil’s Investor’s Business Daily show that winning stocks over the last 50 years had a return on equity(ROE) of 17% or more. Any CANSLIM-worthy stock should demonstrate this kind of ROE in each of the last three years. The higher the annual growth, the better the candidate.

N = New Products, New Management, and New Highs– The company should offer new products/services, with new management and/or industry innovations. A pivotal technical consideration of this point is to buy only stocks that are emerging from basing chart patterns and that have put in a new stock-price high out of the base or consolidation. Zanger looks for companies that have a global domination in their market space and that are also “under-known and under-owned.” This means institutions that don’t yet have these stocks in their portfolio are to become major buyers, at which point they create demand for the stock and in turn push up the stock price.

S = Supply and demand in share volume/shares that float – The supply part (shares outstanding) is of less importance here than demand. The company should demonstrate increasing volume as price moves out of a basing chart pattern such as a cup and handle, saucer bottom, or head and shoulders bottom. Other patterns such as flags or pennants and bullish wedges also represent excellent buying opportunities when the breakouts are accompanied by greater-than-average volumes. Other major factors are the total number of shares that the public can buy, and this is known as the float. A small number of shares that float means that fewer shares have to be bought to push up the stock price. Dan likes to see stocks with 3 million to 100 million shares that float. TASR, one of Dan’s big winners in 2003-2004, started out with just 3 million shares that floated on its 5000% run in one year.

L = Leader (or Laggard)? – Buy market, sector and industry leaders. Sell laggards. Own the industry leaders and sell them when they no longer lead. This also applies to the sectors and groups in which they reside.

I = Institutional sponsorship – Look for stocks with a good degree of institutional (= professional) participation. This includes those with a higher degree of corporate executive ownership.

M = Market direction – As much as 70% of a stock’s price movement is determined by the direction of the overall market. Even a winner will be fighting a strong current to get to higher prices in a market that is tanking. It is best to be long winners in a bull market (and short losers in a bear market).

Other fundamentals of importance include:

  1. Short interest – A large short interest gives a clue as to what other traders are doing. A general rule of thumb is to avoid stocks with more than 5% of the float held short.
  2. Insider selling – Insider activity can often provide valuable indications of where a stock may be heading. If insiders are buying for the first time in a number of months, they might be accumulating stock in anticipation of a positive event. If they are dumping, what do they know that you don’t? More on this in my article “Can Insiders Help You Make Better Trades?”

Once a stock has been identified as a potential CANSLIM candidate, Zanger watches it for a few days to make sure it is not simply a one-day wonder. Some of his big winners in 2003 -2004 have included Research in Motion (RIMM), E-Bay (EBAY), Kmart (KMRT), Taser, INC. (TASR), NVE Corp (NVEC), PalmOne (PLMO), and Travelzoo (TZOO).

Zanger offers one important caveat: while it’s true that most stocks that he trades are CANSLIM stocks, there are two important exceptions that show why checking the fundamentals is so important. Firstly, he says that Biotechs often act like CANSLIM stocks but don’t have earnings growth and other positive criteria. And secondly, he says that near the end of a major bull run in the markets, after most of the quality stocks have already moved and are starting to exhaust themselves, the trash stocks will get pushed higher as investors scramble to find the “next big thing.” A rising tide lifts all boats including those that don’t have the fundamentals behind them. Loading up on these trash stocks late in the game can lead to serious losses and a situation that can be avoided by looking at the fundamentals.

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