There are several main factors of successful investing, but few are more important than the strategy you employ. Most investing courses that teach you how to make money in stocks go into great detail with regard to strategies and the importance of following them.
The reason is simple. Investment strategies are designed to tell you when to enter and exit investments and which investments have the highest probability of generating profits. By following a strategy, you increase your chances of making successful investment decisions, which affects your overall profitability.
One common strategy investors looking to outperform the market use is known as the CANSLIM strategy. What is CANSLIM, and can it help you pick high-growth stocks?
What Is the CANSLIM Investment Strategy?
Invented by Investor’s Business Daily founder William J. O’Neil, the CANSLIM investing strategy, also known as the CAN SLIM system, was designed to find and take advantage of high growth stock opportunities.
Using a mix of fundamental analysis and technical analysis, the strategy helps investors determine the best stocks to invest in based on a series of seven criteria. The acronym CANSLIM points to the seven criteria growth investors should look for as they take part in stock picking:
C: Current Quarterly Earnings
Many of the factors involved in the CANSLIM system include the same statistics most growth investors look for, including the C — current quarterly earnings per share (EPS).
EPS compares the amount of profit the company has generated on a per-share basis to the cost of each share of the company. For example, if there are 1 million shares of ABC stock available,and the company generated $1 million in profits in the last quarter, the EPS for that quarter is $1, or $1 million in profits divided by the 1 million shares available.
When following the CANSLIM strategy, investors look for a current trend of compelling growth in a company’s quarterly earnings, with EPS expected to maintain a year-over-year growth rate of at least 20%.
A: Annual Earnings Growth
The current quarter’s earnings growth is important because it shows whether the company you’re considering investing in is experiencing strength at the present moment. However, investors who employ the CANSLIM strategy are looking for stocks that have a clear history of growth that’s likely to be followed by more of the same.
The A in the acronym stands for annual earnings growth.
The strategy suggests investors should only invest in stocks that have consistently created significant earnings growth over at least the past five years. Look for at least 20% growth in profitability for five consecutive years. If a stock hasn’t maintained this high level of growth, most CANSLIM investors move on to the next opportunity.
N: New — New Products, New Management, or New Information
The strongest companies on the stock market are known for generating consistent news flow. Stories about everything from new products to new management and new technologies have the ability to send a stock screaming for the top, and those that experience the most growth release these stories on a relatively regular basis.
Look into the press releases issued by the company recently and see whether any market-moving news has been released. Has there been a promising new member added to the board of directors? Is a new product expected to hit the market over the next year?
Essentially, you want to make sure the stock you’re interested in maintains a position within mainstream financial headlines. News from a company can be a catalyst for big price movements.
S: Scarcity of Share Supply
Price movement in the market is simply a matter of supply and demand.
As with any other product — be it milk, lumber, or gasoline — there’s only a limited supply of any given stock on the market at any given time. When the demand for a stock outpaces supply, the price of that stock must increase. The higher cost to new buyers reduces the demand until it reaches equilibrium.
On the other hand, when the supply of a stock outpaces demand, prices must fall to make that stock more appealing to investors. As the price falls, the now less-expensive stock begins to see an increase in demand.
Investors who employ the CANSLIM strategy tend to compare the trading volume of a stock — the number of shares that trade hands on an average trading day — to the total number of outstanding shares on the market at the time. The closer trading volume is to the number of shares outstanding, the more demand is likely to overtake supply, sending the stock’s price to the top.
Investors employing this strategy also look for companies that have a history of share buybacks. A share buyback happens when a publicly traded company purchases shares of its own company on the open market. This is good for two reasons:
- Supply and Demand. When a company purchases shares of its own stock, it’s essentially pulling available supply off the market. As described above, when there’s not enough supply of a stock to meet investor demand, the price of the stock increases due to scarcity.
- Return of Value. Share buybacks are a great return of value for shareholders. Think of outstanding shares as a piece of pie. When the pie is cut into more pieces, each piece becomes smaller — in the case of shares of stock, each share becomes less valuable. With share buybacks, the company is essentially cutting fewer pieces of the pie, making each share more valuable.
L: Laggard Stocks
Investors who employ the CANSLIM strategy look for laggard stocks, which is actually a play out of the value investors’ playbook. The idea here is to find stocks that have underperformed compared to similar stocks within their sector with similar fundamentals.
The thinking is that by investing in laggards, eventually an undervalued stock will rise to or above its fair market value, resulting in tremendous returns.
To determine whether a stock is a laggard within its category, investors look to the relative strength index, or RSI. Stocks with an RSI below 30 are considered to be undervalued compared to their peers.
Investors also look to relative price strength, or RPS, to determine if a stock is undervalued compared to its peers. The RPS is a technical indicator that compares the price movement experienced by a stock to that of the market as a whole. An RPS of less than 1 suggests the stock is undervalued, and a good candidate for investors following the CANSLIM strategy.
I: Institutional Sponsorship
CANSLIM iInvestors look for stocks that have some institutional ownership, but not too much. One of the goals is to invest in a stock before the majority of institutional investors realize the opportunity, thereby taking advantage of significant profits as institutions like mutual funds and private equity firms buy large blocks of shares.
While you want to get in before the majority of institutions, taking advantage of the shift of supply and demand as they dive in, it’s also important that you invest in companies that institutions actually will have interest in. So, there’s a careful balance here.
Look for companies that have two or three strong institutional investors with compelling track records, but make sure that no more than 20% of the outstanding shares of the company are currently being held by big-money players. This setup suggests the stock is something institutions would be interested in, while also ensuring there’s plenty of room for more institutions to dive in.
M: Market Averages
The CANSLIM investing strategy was designed for use during bull markets. When using this strategy, it’s important to pay close attention to the overall market direction.
You can assess the direction of the overall market by looking into stock market indexes like the Dow Jones Industrial Average, which tracks average growth among large companies in the United States, or the Nasdaq, which tracks the technology market closely.
Pros and Cons of the CANSLIM Strategy
As with any investing strategy, there are pros and cons to CANSLIM. Some of the most important to consider include:
Pros of CANSLIM
This investing strategy is especially popular among growth investors. Strategies don’t become this popular without several perks to using them. Some of the biggest advantages of the CANSLIM strategy include:
1. Significant Profits Within Reach
Through this strategy, investors essentially have a roadmap to the investing process that makes it possible to generate profits significantly above and beyond what the average investor generates by investing in index funds, exchange-traded funds (ETFs), and other investment vehicles designed to track the market or specific industries.
2. No Guesswork
Investing tends to come with guesswork. After all, it’s impossible to predict the future, and when you invest, you’re predicting that a company will do well and the value of a stock will rise.
Those who follow the CANSLIM strategy follow a specific set of criteria that takes the guesswork and emotion out of the equation. If any one of the factors required for a stock to fit into the strategy doesn’t match up, CANSLIM investors move on to the next opportunity.
3. An Educated Approach
The basis of CANSLIM is educating yourself about an investment opportunity before actually pulling the trigger. The strategy requires you to look at the company you’re considering buying a piece of under the microscope, not just basing your decision on what the company’s doing today, but what it did yesterday and what it will do tomorrow.
Moreover, the strategy requires you to look into the overall market to ensure conditions are perfect for an investment. Few strategies require investors to go into this much detail, and while doing so may be somewhat cumbersome, the process protects you from making mistakes based on a lack of understanding of what you’re investing in.
4. An Institutional Mindset
Every one of the metrics involved in the strategy are those that institutional investors — also commonly referred to as “smart money” — look at before making their investments. As a result, when following the strategy, you take on the mindset of an institution.
Often, following the strategy results in a small investor diving into a stock before the institutions realize the opportunity exists, giving you the ability to benefit from the upside as institutions catch on.
5. Fast Markets
The strategy is designed for use in fast-paced bull markets. As a result, it brings a bit of excitement to the investing process, making it more fun to build wealth in the stock market.
Cons of CANSLIM
While CANSLIM has led plenty of investors from rags to riches, there are also drawbacks to consider. After all, there must be a dark cloud for a silver lining to exist. Some of the most important drawbacks to consider before using the strategy include:
1. Market Performance Dependent
This strategy is best used during bull markets when stocks are trading up on a regular basis. When bear markets take hold, the strategy can — and often does — lead to losses.
2. Short-Term Investments
Following the strategy, you’ll be investing in growth stocks that fit into a specific set of criteria. However, stocks don’t generally fit these criteria for long. As a result, the strategy requires added research because investors will need to continuously look into stocks they’ve already purchased to ensure they still fit into the strategy. This can take up quite a bit of time.
The stocks that tend to experience the highest levels of growth in the market also tend to experience the highest levels of volatility.
Volatility is a measure of the speed of price fluctuations, regardless of whether the price is moving up or down. As a result, highly volatile stocks are risky to invest in. After all, they have the potential to fall just as fast as they climb. Failing to pull out of an investment that’s going in the wrong direction can lead to significant losses.
Does CANSLIM Work?
This is the million-dollar question. Regardless of whether a strategy works for someone else, deciding whether it will work for you can be difficult. What can be said to be generally true is that the strategy has a history of outperforming markets.
According to the American Association of Individual Investors, the strategy has outperformed the top 15 benchmarks for the U.S. market since 2006. Depending on how you employed the strategy, using it since 2006 would have returned annualized gains of between 15.2% and 20.9%.
To put that into perspective, since 2006 the annualized gains of the top stock market indexes were 6.4% for the Dow Jones, 6.5% for the S&P 500, and 12.0% for the Nasdaq 100.
When to Use the CANSLIM Investment Strategy
As with most other investment strategies, the CANSLIM strategy wasn’t designed to be used every day. Market conditions have to be just right for the strategy to be the most advantageous.
The strategy is best used just after a consolidation takes place. Consolidation is a technical term that describes a chart pattern in which a stock trades between clear support and resistance lines for a period of time. Following a consolidation, a breakout will take place, either breaking below support to new lows or breaking above resistance to new highs.
The CANSLIM strategy is best used when the overall market has completed a consolidation pattern and begins to move upward. This suggests the upward movement ahead will be a strong, momentous run, giving you the opportunity to generate outsize gains.
These are the best conditions in which to use the CANSLIM strategy:
- Bull Markets. This strategy is a growth investing strategy. Growth strategies are best used when markets are moving in the upward direction. If markets are moving into negative territory, you should choose a different strategy, such as value or income investing.
- After Consolidation. It’s important to wait until a stock breaks a consolidation pattern. If you use the strategy to purchase a stock during consolidation, there’s a chance the breakout will be either bullish or bearish. Of course, a bullish breakout would make for a great investment. Conversely, if the stock breaks in the bearish territory, significant losses may be the result. So, it’s best to wait for the breakout, which often requires a bit of patience.
- Calm Markets. Markets are sometimes choppy, with some assets climbing while others fall. Sometimes the market is volatile, with big swings up one day and big drops the next. The movement in choppy markets takes place at the whims of the investing community, which are nearly impossible to predict. As such, it’s important to make sure the market is moving steadily and calmly in the upward direction overall when you use this strategy.
Who Should Use the CANSLIM Strategy?
There’s no such thing as a one-size-fits-all investment strategy because every investor has their own unique goals. Some investors want outsize growth and are willing to accept the risk that comes with it, while other investors are happy with low-risk income stocks.
CANSLIM isn’t just a growth investing strategy — it’s an aggressive growth strategy, which is one of the reasons it requires such detailed research prior to buying or selling a stock. As a result, there is a very specific group of investors that should consider taking advantage of the strategy:
- Risk Tolerance. Aggressive growth strategies are designed to generate gains that outperforms the overall market. However, where there’s an opportunity for large gains, there’s also the possibility of large losses. This strategy should be used only by investors with a relatively high risk tolerance.
- Research Capabilities. Stocks that fit into this strategy have very specific metrics, many of which take a bit of research to find. It’s important that you have experience researching opportunities in the market in detail and are confident in your ability to do so. If you find yourself scratching your head wondering what this or that metric means, consider furthering your research capabilities before attempting to deploy this strategy.
- Experience. Much of this boils down to experience. Those who use this strategy successfully are generally highly experienced investors who know their way around the intricate system of the stock market.
If you don’t have a high risk tolerance, have a hard time understanding Wall Street jargon, or have little experience in the market as a whole, it’s likely best to avoid using this strategy.
Nonetheless, if you’re determined to give the CANSLIM strategy a shot, make sure to take advantage of trading simulators to test your skills for a few months prior to putting real hard-earned dollars at risk.
There’s no question the CANSLIM investing strategy has led many investors to wealth in the market. Few would debate that the strategy’s inventor, William J. O’Neil, is a financial genius.
However, it’s important to remember that a strategy that’s a good fit for another investor won’t always be a good fit for you.
Choosing your strategy is one of the most important decisions you’ll make as you start investing. When doing so, you should take all factors into account — not just the potential gains, but also the potential losses and the work involved in successfully deploying the strategy.
There are clear perks to following the CANSLIM system. You’ll be required to learn quite a bit about the stocks you’re investing in, and you’ll have the potential to generate returns far and above averages in the market.
However, you’ll also be required to have a detailed understanding of the market and a relatively high risk tolerance. So, it’s not the best strategy for beginners or investors with a low appetite for risk.