Technical Analysis from A to Z

CANSLIM

Overview

CANSLIM is an acronym for a stock market investment method developed by William O'Neil. O'Neil is the founder and chairman of Investor's Business Daily, a national business newspaper. He also heads an investment research organization, William O'Neil & Company, Inc.

Drawing from his study of the greatest money-making stocks from 1953 to 1985, O'Neil developed a set of common characteristics that each of these stocks possessed. The key characteristics to focus on are captured in the acronym CANSLIM.

Current quarterly earnings per share
Annual earnings growth
New products, New Management, New Highs
Shares outstanding
Leading industry
Institutional sponsorship
Market direction

Although not strictly a technical analysis tool, the CANSLIM approach combines worthy technical and fundamental concepts. The CANSLIM approach is covered in detail in O'Neil's book, How To Make Money In Stocks.

Interpretation

The following text summarizes each of the seven components of the CANSLIM method.

Current Quarterly Earnings

Earnings per share ("EPS") for the most recent quarter should be up at least 20% when compared to the same quarter for the previous year (e.g., first quarter of 1993 to the first quarter of 1994).

Annual Earnings Growth

Earnings per share over the last five years should be increasing at the rate of at least 15% per year. Preferably, the EPS should increase each year. However, a single year set-back is acceptable if the EPS quickly recovers and moves back into new high territory.

New Products, New Management, New Highs

A dramatic increase in a stock's price typically coincides with something "new." This could be a new product or service, a new CEO, a new technology, or even new high stock prices.

One of O'Neil's most surprising conclusions from his research is contrary to what many investors feel to be prudent. Instead of adhering to the old stock market maxim, "buy low and sell high," O'Neil would say, "buy high and sell higher." O'Neil's research concluded that the ideal time to purchase a stock is when it breaks into new high territory after going through a two to 15 month consolidation period. Some of the most dramatic increases follow such a breakout, due possibly to the lack of resistance (i.e., sellers).

Shares Outstanding

More than 95% of the stocks in O'Neil's study of the greatest stock market winners had less than 25 million shares outstanding. Using the simple principles of supply and demand, restricting the shares outstanding forces the supply line to shift upward which results in higher prices.

A huge amount of buying (i.e., demand) is required to move a stock with 400 million shares outstanding. However, only a moderate amount of buying is required to propel a stock with only four to five million shares outstanding (particularly if a large amount is held by corporate insiders).

Leader

Although there is never a "satisfaction guaranteed" label attached to a stock, O'Neil found that you could significantly increase your chances of a profitable investment if you purchase a leading stock in a leading industry.

He also found that winning stocks are usually outperforming the majority of stocks in the overall market as well.

Institutional Sponsorship

The biggest source of supply and demand comes from institutional buyers (e.g., mutual funds, banks, insurance companies, etc). A stock does not require a large number of institutional sponsors, but institutional sponsors certainly give the stock a vote of approval. As a rule of thumb, O'Neil looks for stocks that have at least 3 to 10 institutional sponsors with better-than-average performance records.

However, too much sponsorship can be harmful. Once a stock has become "institutionalized" it may be too late. If 70 to 80 percent of a stock's outstanding shares are owned by institutions, the well may have run dry. The result of excessive institutional ownership can translate into excessive selling if bad news strikes.

O'Neil feels the ideal time to purchase a stock is when it has just become discovered by several quality institutional sponsors, but before it becomes so popular that it appears on every institution's hot list.

Market Direction

This is the most important element in the formula. Even the best stocks can lose money if the general market goes into a slump. Approximately seventy-five percent of all stocks move with the general market. This means that you can pick stocks that meet all the other criteria perfectly, yet if you fail to determine the direction of the general market, your stocks will probably perform poorly.

Market indicators are designed to help you determine the conditions of the overall market. O'Neil says, "Learn to interpret a daily price and volume chart of the market averages. If you do, you can't get too far off the track. You really won't need much else unless you want to argue with the trend of the market."