When participating in the stock market, investors often use various techniques and methods to evaluate stocks, and one highly favored method is CANSLIM. So what is CANSLIM Investing Method in the stock market, where does it originate, and how is it used? All of this will be explained in detail by invest286.com in the content below.
Contents
CANSLIM Investing Method Guide
What is CANSLIM?
Like most stock trading strategies, the goal of CANSLIM is to help traders find stocks with superior potential compared to the general market and other stocks in the same industry.
CANSLIM is only applied in a rising market because it is designed to make money from stocks when the market is in an uptrend.
The CANSLIM method, when applied in a bullish market, focuses on purchasing high beta stocks, which usually perform well in rising market conditions.
What distinguishes the CANSLIM approach from other stock investment strategies is its integration of both technical and fundamental analysis. It employs technical indicators to identify optimal times for buying and selling stocks, and simultaneously uses fundamental indicators to assess a company’s efficiency and growth potential.
Origin of the CANSLIM Investing Method
Now that we understand what is the CANSLIM investing method, let’s delve into the person who created it: : William J. O’Neil.
William J. O’Neil was born in 1933. In 1958, after receiving a degree in business from Southern Methodist University, he began working at Hayden, Stone & Co. as a stockbroker.
O’Neil started using his CANSLIM investing method strategy to select stocks. Essentially, his strategy has remained largely unchanged over the years, meaning the version he used in the 1950s is not significantly different from the one used today.
By relying on the CANSLIM investing method, O’Neil quickly outperformed his peers. Shortly after joining Hayden, Stone & Co., O’Neil became the top-performing stockbroker in the company. O’Neil achieved remarkable success just five years after working with Hayden, Stone & Co., after which he decided to start his own independent venture.
In 1963, O’Neil founded William O’Neil & Co. The company continued to implement O’Neil’s CANSLIM trading method and achieved significant success.
O’Neil based his strategy on statistical analysis of the historical price movements of stocks. He then discovered some very interesting facts that broke many commonly held investment principles. For example:
Buying low and selling high.Catching bottoms when the market hits support levels.Only buying stocks with low P/E ratios.Applying dollar-cost averaging.
To present a fascinating paradox:
Stocks that seem to have high prices and a lot of risk according to most people tend to go even higher. Meanwhile, stocks that appear cheap and are at lows tend to go even lower.
7 Stock Screening Criteria in the CANSLIM Method
The significant advantage of CANSLIM Investing Method is that it helps determine whether a stock is worth investing in or not. To apply this method, you only need to compare a stock with the following 7 CANSLIM criteria:
C – Current Quarterly Earnings
The first criterion of the CANSLIM investing method for screening stocks is based on the current quarterly earnings per share (EPS), and a higher EPS is better. To calculate EPS, you divide the net profit by the number of shares outstanding.
Requirement for criterion C: Companies should have current quarterly EPS growth of at least 18% to 20% compared to the same period in the previous year.
It’s important to note that this income should come from the core business activities of the company, not extraordinary profits, such as asset sales.
Example: If you are evaluating Company A, you need to compare its Q1 2022 EPS with Q1 2021 (to remove seasonal factors). If the growth rate is only 16%, it does not meet the CANSLIM criterion, and you should exclude the company.
By analyzing quarterly earnings growth, you can gain insights into a company’s profitability. A company with high EPS growth signifies both profitability and rapid growth.
A – Annual Earnings
According to the CANSLIM method, you should look for stocks with high growth in annual earnings over three consecutive years, meaning there should be earnings growth every year.
Requirement for criterion A: Depending on the company and industry, try to achieve annual earnings growth of 25% or higher.
However, even if a company meets the threshold for annual earnings growth, it may not fully satisfy CANSLIM requirements. This is because the annual earnings requirement is not just about finding companies with high growth but also ensuring that they use those earnings wisely. A company can have a short-term successful period with increasing profits for a few years. But if the company does not reinvest its earnings intelligently, this growth may not be sustainable.
Although there is no way to guarantee that a company will use its money wisely, considering the return on equity (ROE) in this context can provide additional insights.
According to CANSLIM, the ROE should be 17% or higher.
By looking at annual earnings growth and ROE, you can assess whether a company that has been profitable in recent years can continue its growth in the coming years.
N – New (New Products, New Management)
In O’Neil’s analysis in the CANSLIM strategy, companies need something new to drive growth.
“New” can be understood in various ways, such as new products, new management, new marketing strategies, and more.
Most companies in the stock market are constantly changing and evolving in some way. Therefore, this criterion is not too difficult to meet. Sometimes, even a minor adjustment in the company’s operations can satisfy this CANSLIM criterion.
If you are unsure whether a company meets the “NEW” requirement, the question you need to answer is whether this new element can significantly impact the stock’s price. If the answer is NO or UNCERTAIN, then consider excluding the company from your CANSLIM investment portfolio.
S – Supply and Demand
Supply and demand theory is a fundamental concept in finance and economics. At its simplest, it suggests that when demand exceeds supply, prices rise, and when supply exceeds demand, prices fall.
Applying supply and demand in the CANSLIM method refers to considering the demand for a stock and the number of shares of the company’s stock available in the market.
The CANSLIM strategy recommends selecting stocks with a limited float. When a company grows in the future, increased demand for its stock, combined with limited supply, can drive up the stock price.
Additionally, O’Neil recommends:
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Buying stocks with higher average daily trading volumes than the three-month average.
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Prioritizing companies that buy back shares from shareholders, as it indicates confidence in the company’s future direction.
In summary, the supply and demand principle in CANSLIM is a supporting factor in stock selection. Simply put, increasing trading volume while decreasing supply is favorable.
L – Leader or Laggard
Consider whether the company is a leader or laggard in its industry.
According to O’Neil, a way to evaluate if a company meets this criterion is to refer to industry rankings, often published on financial websites.
For instance, if you are analyzing a stock in the banking sector in Vietnam, you can check the rankings on websites like vcsc.com.vn.
Evaluating a potential stock compared to competitors and the overall market is necessary. Even if a company has high profits, it may still lag behind other stocks in the sector when the market is performing well.
It is recommended to use the Relative Strength (RS) index to evaluate a company’s performance relative to the rest of the sector. Each stock is ranked from 1 to 99, with an RS of 99 indicating that the stock has outperformed 99% of other stocks in terms of price performance over the past year.
Requirement for criterion L: Choose stocks with a Relative Strength (RS) index of 80 or higher.
I – Institutional Sponsorship
Another criterion in the CANSLIM investing method is that stocks should have a sufficient number of institutional shareholders. Institutions can include mutual funds, insurance companies, banks, and proprietary trading desks of brokerage firms.
Why is institutional ownership necessary?
Institutional investors often have more expertise and resources than individual investors. Attracting investment from institutions is a positive signal for a company, indicating that the company has gained trust.
In the CANSLIM criteria, this is one of the more complex factors to consider. Typically, CANSLIM investors prefer to invest in a company before institutions do, as when institutions invest, it can significantly push up the stock price.
Furthermore, not all institutional investors are equally good, so you need to assess the quality of these institutions. There is a ranking of institutional fund performance on Investor’s Business Daily based on their performance over the past 36 weeks. O’Neil recommends only considering funds ranked B+ or higher.
M – Market Direction
The final criterion in the CANSLIM method is the direction of the market.
O’Neil believed that even if a stock meets the first six criteria, making an incorrect prediction about the market’s direction could result in losses. He claimed that identifying market tops or bottoms accurately accounts
If the market doesn’t rise, wait to apply the CANSLIM method instead of trying to make a trade and losing money.
Trading Rules of the CANSLIM Method
After understanding what the CANSLIM investing method is and the criteria that make it up, you should also know that CANSLIM comes with a set of rules to follow to execute it and avoid losses in trading.
Set Stop Loss at 8%
If institutional investors cannot buy and withdraw stocks from the market quickly, individual investors can. For O’Neil, this could be the secret to becoming wealthy for retail investors.
The unbreakable rule here is to cut all losses at 8%, which is the maximum acceptable loss level.
O’Neil also mentioned that most investors are backward. Instead of cutting losses quickly, most “hold their breath” and hope the stock returns to the break-even point before selling, which often leads to mistakes.
Set Profit-Taking at 20% – 25%
O’Neil also suggests taking profits at 20% – 25%. There is only one exception to this principle: if a stock rises 20% within 2 to 3 weeks, you can hold it for another 8 weeks before considering whether to hold it for 6 months or not.
O’Neil recognized a common trend that good stocks often tend to rise 20 – 25%, then pull back before starting a new trend and continuing to rise.
Apply Buying on the Way Up
Apply the strategy of buying on the way up, which means buying more as the stock price rises. William O’Neil said that he often buys more shares when the price increases by 2 – 3% compared to the initial purchase price. However, if the price rises more than 5%, he will not buy to avoid risk.
Avoid Buying Extremely Cheap Stocks
There are rare exceptions, but generally, stocks that are extremely cheap have reasons for their low prices, and the main reason is often the lack of significant potential for price appreciation. On the other hand, stocks with high EPS (earnings per share) tend to have higher prices, and their future prices may be even higher.
Remember: “There is no stock too expensive to buy, and there is no stock too cheap to sell.”
If you want to follow the CANSLIM method, do not buy stocks based on the P/E ratio because many companies have high P/E ratios, but their future prices can continue to rise, and vice versa.
Use Technical Analysis to Determine Entry Points
Using technical analysis to identify entry points is a crucial factor in the success of the CANSLIM strategy.
O’Neil often decides to buy when the price follows the “Cup and Handle” or “Volatility Contraction” (VCP) patterns.
Mistakes When Using CANSLIM by Investors
When researching what the CANSLIM method is and reading William O’Neil’s book about this method, in Chapter 13, I found O’Neil mentioning a section on “21 common costly mistakes that most investors make.”
- Holding onto losses without cutting them, believing that the stock will eventually rise.
- Buying stocks while they are in a downtrend. For example, seeing a stock drop to $20, then buying it, and later seeing it drop to $15 and continuing to buy, thinking you are getting a better deal.
- Preferring to apply the dollar-cost averaging strategy (similar to the previous point).
- Hesitating to learn how to use charts and avoiding buying stocks on an uptrend.
- Setting poor selection criteria and not understanding what to look for in a potential business. Additionally, focusing too much on highly speculative, low-quality securities.
- Not having specific market rules to know when to buy and when to sell.
- Lacking patience and failing to adhere to the established buying and selling rules, leading to increasing mistakes.
- Focusing only on what to buy and neglecting to research when it is best to sell.
- Not understanding the importance of investing in quality companies that have many institutional investors. Also, not comprehending the importance of using charts to save a lot of time in stock selection.
- Preferring to buy many low-priced stocks rather than a few high-priced ones.
- Buying based on recommendations, rumors, stock splits, mergers, or other events.
- Favoring “second-tier stocks” because of dividends or low P/E ratios.
- Always wanting to make money quickly and easily.
- Tending to buy familiar company names.
- Struggling to recognize good information/advice to act upon.
- Taking small profits and being quick to take losses.
- Worrying too much about taxes and transaction costs.
- Speculating too much in derivative products because they are seen as a quick way to get rich.
- Rarely trading “at the market” instead of setting price limits for buy and sell orders.
- Struggling to make decisions when needed.
- Failing to objectively evaluate stocks.
I’m sure many of you can relate to having made more than half of these mistakes during your investing journey. This is likely why you haven’t achieved favorable results in the stock market.
“Fix your weaknesses until they become strengths” – William J.O’Neil
Is the CANSLIM Investing Method effective?
As you can see, each criterion among the seven CANSLIM criteria is relatively simple and understandable, and the trading rules are also easy to implement for most traders. This might make you wonder if something as straightforward as CANSLIM can genuinely help traders select good stocks.
Historically, CANSLIM has outperformed the market in creating an investment portfolio. O’Neil himself is proof that the CANSLIM method is effective. Moreover, many other investors have also followed this method and achieved very positive returns.
However, the most significant limitation of CANSLIM is its effectiveness in emerging or international markets. CANSLIM was developed for the U.S. stock market, so its criteria and indicators are more suitable for the U.S. market. Applying it to other markets may result in slightly less effectiveness.
Nevertheless, we cannot underestimate the CANSLIM method because its criteria and principles are based on sound, scientific foundations. If you understand them correctly and know how to adapt them to the current market conditions, it can be an effective investment strategy.
CANSLIM is a stock selection strategy based on seven criteria (C-A-N-S-L-I-M). After learning about CANSLIM, you have summarized the most important aspects of this method:
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Only decide to buy when the market is in an uptrend, and always be prepared to act when the market enters a downtrend.
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Do not buy stocks that are too cheap, and also avoid buying stocks solely for dividends or low P/E ratios.
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Buy stocks with a minimum ROE of 17% or higher.
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Stocks should have recent EPS growth (compared to the same period last year) of more than 18%.
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Buy stocks from companies with annual profit growth of at least 25%, even up to 40% for leading stocks.
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Only buy stocks within the leading companies in the industry.
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Ensure that the stock you buy has the participation of institutional investors.
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The company must have popular products/services and new factors to achieve a significant revenue increase in the future.
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Buy stocks when they reach new all-time highs and experience significant volume spikes.
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Always focus on researching and assessing the market, especially knowing how to read charts and analyze price movements.
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Cut losses at 7 – 8% from the purchase point, do not argue with the market, and do not console yourself that the stock will soon rise.
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Buy stocks on average as the price increases, but do not buy more if the price increases by 5% from the purchase point, and take profits when the stock rises by 20 – 25% from the purchase point.
However, the truth is that finding a stock that meets all these criteria is not straightforward at all. Therefore, even finding a stock that comes close to meeting these criteria can ensure that it is a good stock with potential and less risk compared to hundreds of other stocks in the market.
These are all the pieces of information about CANSLIM investing Method that invest286.com wants to share with you. By applying CANSLIM to stock investment, you will have a relatively effective and intelligent investment formula because CANSLIM has proven its effectiveness over the years in the U.S., European, and Vietnamese stock markets. I wish you success soon.
