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| The Basics | 7 signs a stock is ready to soar
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The publisher of Investor's Business Daily developed the CANSLIM strategy by pinpointing the characteristics of big-growth stocks. Here's a way to screen for them yourself.
By Harry Domash
Wouldnt it be great if you could find stocks with the potential to produce enormous gains, maybe increase five or 10 times in value over the next year or two? Its easy to find plenty of stocks that have already done that, but how do you spot them before they take off?
Evidently, Investors Business Daily publisher William J. ONeil pondered that same question some years ago. But unlike you and me, ONeil was in a position to find out.
His William ONeil & Co. had been using computers to analyze the stock market since the 1950s, and as a byproduct, ONeil amassed a large database containing fundamental and price action data on thousands of stocks.
O'Neil scanned his database to pinpoint the 500 stocks scoring the biggest gains over the 40-year period from 1953 to 1993. He then analyzed the list to find out what these winning stocks had in common before they started their big move.
ONeil discovered seven characteristics shared by most of the biggest gainers and combined them into a strategy for finding future rockets.
He named his selection strategy CANSLIM, an acronym of the seven required factors. He first described CANSLIM in his best-selling book: How to Make Money in Stocks, now in its third edition.
At its heart, CANSLIM is a momentum system, requiring fast earnings growth combined with a strong price chart. But it also includes other requirements not usually identified with momentum investing.
ONeils Investors Business Daily newspaper is organized around the CANSLIM strategy. Its stock tables and price charts include just about everything you need to find CANSLIM stocks. But you dont necessarily have to subscribe to the newspaper to find CANSLIM stocks. Although not an exact match, you can come close using MSNs Deluxe Screener. I developed this screen to find stocks meeting the CANSLIM requirements ONeil described in his book.| Does CANSLIM work? | The American Association of Individual Investors (www.aaii.com) tests more than 50 gurus' stock-selection strategies on an annual basis. Using a screen designed to emulate each strategy, the AAII constructs a portfolio at the beginning of each calendar year and tracks each portfolios performance for the year. Then it builds a new portfolio at the beginning of the following year.
For the years 1998 through 2003, AAIIs CANSLIM portfolios produced annual returns of 28.2%, 36.6%, 38%, 54.4%, 20.5% and 79%, respectively. CANSLIMs 704.8% cumulative six-year return ranked second of all strategies tested. Thats not bad, considering that three of those years produced negative market returns, the worst of times for momentum strategies.
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Here are the seven requirements in the CANSLIM strategy, and a description of how I translated each of them into search parameters.
C = Current (quarterly) earnings growth
The linchpin of the strategy is strong earnings growth. ONeil wants stocks with big increases in quarterly per-share earnings compared with the year-ago quarter, and the bigger the better. Some 75% of the winners in ONeils study reported quarterly EPS jumps of 70% or more before they took off. In his book, ONeil specifies a minimum 18% quarterly year-over-year EPS growth. Try increasing the minimum growth requirement to 25% if your screen turns up too many stocks.
Screening Parameter: EPS Growth Qtr vs. Qtr >= 18%
Huge increases dont mean much if youre comparing EPS with a minuscule year-ago number. O'Neil advises ignoring high growth figures if the year-ago earnings were exceptionally small. The screener doesnt have a year-ago quarterly EPS parameter, but I achieved the desired result by setting the maximum acceptable year-over-year quarterly EPS growth at 500%, thereby eliminating stocks with ridiculous growth rates caused by small year-ago figures.
Screening Parameter: EPS Growth Qtr vs. Qtr <= 500%
A = Annual earnings growth
Strong last-quarter gains arent enough. ONeil also wants to see at least 25% year-over-year annual earnings growth, and higher is better.
Screening Parameter: EPS Growth Year vs. Year >= 25%
ONeil rules out stocks with high recent earnings but losses or little or no earnings in previous years. He wants to see a consistent longer-term growth history. You cant screen for that directly, but I added three checks to limit the field to stocks likely to meet that requirement.
I require earnings per share from continuing operations totaling at least $1 during the trailing 12 months, and at least 50 cents per share in the last fiscal year. Finally, I use return on equity, a profitability measure, to further reduce the chances of picking up stocks with an erratic earnings history. I do that by requiring at least 5% return on equity, on average, over the past five years.
Screening Parameter: 12-Month EPS: Cont. Ops. >= 1.00
Screening Parameter: Latest Fiscal EPS >= $0.50
Screening Parameter: ROE 5-year average >= 5%
N = New highs
ONeil wants candidates with new products or new management fueling accelerating earnings growth. But those factors are difficult to measure. So ONeil, figuring they will be reflected in the share price, uses stock price action as a stand-in.
ONeil requires that qualifying stocks be at, or close to, a new share price high, preferably after coming out of a consolidation chart pattern. I cant check the consolidation aspect, but I achieve the near new high requisite by specifying that the share price be within 90% and 80%, respectively, of its 52-week and five-year highs.
Screening Parameter: Last Price >= 0.9*52-Week High
Screening Parameter: Last Price >= 0.8*5-Year High
S = Supply and demand
A companys stock price reflects supply and demand for it shares. If demand exceeds supply, the share price moves up, and vice versa. Consequently, ONeil looks for stocks with a limited supply, which he defined as no more than 25 million shares outstanding. He reasoned that once good news hits, there wouldnt be enough shares available to satisfy buyer demand, thereby propelling the stock price up.
Screening Parameter: Shares Outstanding <= 25 million
L = Leader in industry
ONeil wants the leading companies in an industry. But thats difficult to measure, so again, he uses stock price action as a stand-in by looking for stocks that are already outperforming the market. ONeil uses relative strength as his performance gauge. Relative strength measures a stocks price action compared to the overall market. For instance, a 90 relative strength means that the stock has outperformed 90% of all stocks during the past 52-weeks. ONeil requires a minimum 80 relative strength, and higher is better.
Screening Parameter: 12-Month Relative Strength >= 80
ONeil advises sticking with the two or three strongest stocks in an industry. So if the screen turns up several stocks in the same industry, eliminate all but the three strongest performers, as measured by relative strength.
I = Institutional ownership
Institutions are mutual funds, pension plans, insurance companies and the like. ONeil wanted to see some institutional ownership to verify that at least a few of these savvy buyers have checked out the stock and liked what they saw. However since institutional buying drives up the share price, he wanted to get in before most institutional buyers discovered the stock.
Institutional ownership, defined as the percentage of outstanding shares held by institutions, usually ranges from 40% to 95% for well-known stocks. Since ONeil didnt quantify his institutional ownership requirements, I defined some ownership at 5% and set the upper limit at 35%.
Screening Parameter: % Institutional Ownership >= 5%
Screening Parameter: % Institutional Ownership <= 35%
M = Market direction
ONeil advises against applying the CANSLIM strategy in a weak market. That makes sense because most stocks, and especially momentum stocks, go down when the market drops.
Ive found that most CANSLIM picks have market capitalizations below $1 billion, putting them into the small-cap category. The Russell 2000 ($RUT.X) index is a small-cap index and thus best represents the market for CANSLIM stocks. You can probably tell whether the small-cap market is heading up or down by simply looking at the Russell 2000 chart. But as a rule of thumb, consider the index in a downtrend if its trading below its 200-day moving average, and in an uptrend if trading above.
My screen turned up nine CANSLIM candidates last week. Surprisingly, no tech stocks made the list. Three of the picks were regional banks, and two of those, Progress Financial and Resource Bankshares, are in the process of being acquired. The seven remaining:
| January 2004 CANSLIM candidates | | Company | Industry | Recent price | | ACE Cash Express (AACE, news, msgs) | Consumer services | 25.89 | | American Vanguard (AVD, news, msgs). | Agricultural chemicals | 39.10 | | Amsurg (AMSG, news, msgs) | Hospitals | 38.11 | | MidSouth Bancorp (MSL, news, msgs) | Regional Southeast banks | 31.50 | | NovaStar Financial (NFI, news, msgs) | Credit services | 43.65 | | Quality Systems (QSII, news, msgs). | Healthcare information services | 46.75 | | The Hallwood Group (HWG, news, msgs) | Textile manufacturing | 19.24 |
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I applied the CANSLIM selection rules as originally described in the second edition of ONeils book, How to Make Money in Stocks. The rules described in the third edition, which came out last year, vary in some instances. Color me skeptical, but I can't help but wonder if the changes were made to improve the performance of the selection strategy, or to make it more dependent on Investor's Business Daily's proprietary indicators.
ONeil isnt a buy-and-hold investor. He advises taking losses quickly by selling when a stock drops 7% from your purchase price, and holding on to your winners.
At the time of publication, Harry Domash did not own or control shares of any of the equities mentioned in this article.
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