CAN SLIM: Bill ONeils lessons to pick growth stocks

Written by FE Investor Bureau | Updated: Feb 10 2008, 06:25am hrs
Capturing growth can be tricky. There are just so many variables and then there is the euphoria associated with the market, though it is presently missing from the market. However, growth investing will still continue to remain in vogue in India, as the real economy is on an upward track and is expected to continue to be there. So how does an investor get the growth perspective William J O'Neil, the author of several best sellers on investing, could have an answer.

Bill O'Neil, who began his career as a stockbroker in his early twenties, through studies of the greatest stock market winners, uncovered their common characteristics, he articulated them in an abbreviated form, which today is known as CAN SLIM. It is also used as an investment research tool by many. In January 2004, the American Association of Individual Investors' (AAII) studies of over 50 well known strategies found that CAN SLIM outperformed with a 704.9% six-year compounded result (1998 through 2003).

Bill O'Neil has articulated the strategy for identifying growth stocks based on fundamental and technical parameters. He marries strong fundamentals with the potency of timing. Here is a gist of his tenets. When the market is on an upmove, O'Neil stocks have a tendency to move swifter than the market.

CAN SLIM:

C - Investors should locate companies whose current quarterly earnings per share (CEPS) has increased sharply over the previous year's performance. Here, investors need to sift out earnings emanating from non-operational income or one-time profits or losses. Essentially, to weed out earnings distortions. Current earnings per share should be up 25% or more and in many cases accelerating in recent quarters. Quarterly sales should also be up 25% or more or accelerating over prior quarters.

A - Annual earnings increases over the last five years. Annual earnings should be up 25% or more in each of the last three years. Annual return on equity (RoE) should be 17% or more. This can be depicted only by companies, which are fundamentally strong.

N - New products, management, and other new events. In addition, the company's stock has reached new highs. A company should have a new product or service that's fuelling earnings growth. Watch the charts (they are available on many websites) and here look out for the companies emerging from proper chart patterns, and are ready to make new highs. This step captures momentum.

S - Small supply and large demand for a stock creates excess demand, and an environment in which stock prices can soar. Companies acquiring their own stock, reduces market supply and can indicate their expectation of future profitability. Look for low debt-equity ratios. Shares outstanding can be large or small, but trading volume should be big as the stock price increases. In the Indian context it would be smart to look for companies with strong liquidity to take care when you have to sell.

L - Leaders are a better choice over laggards within the same industry. Using the relative strength index (RSI) as a guide can help you locate momentum in the stock. Basically, the RSI is a technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold positions.

Ordinarily, the share can be said to be overbought once the RSI approaches the 70 level. The interpretation is that it may be getting overvalued and therefore could be a good candidate for a pullback. Likewise, if the RSI approaches 30, it is an indication that the share might be getting oversold and therefore likely to become attractive again. However, O'Neil recommends that the stock's Relative Price Strength Rating should be 80 or higher. Here again it becomes imperative to choose the number of days used to calculate the RSI. The RSI is best looked at over a 15-day time-frame and also for a month for a better overall trading perspective, say traders. Moreover, RSI is best used as a valuable complement to other stock-picking tools, as in this case.

Interestingly, a study of the greatest stock market winners found that all-star stocks had, on average, outperformed 87% of the market before they began their most dramatic price advances. In a manner of speaking, if you want to find next year's winning stocks, look at the better-performing stocks today.

I - Institutional support is always a supporting factor. Pick stocks who have institutional sponsorship by a few institutions with recent above average performance. However, investors are warned to be cautious of stocks that are over owned by institutions.

M - Knowing market direction is critical and this can be done by reviewing market averages daily.

So all in all, it is about getting the lard out and getting slim and alert in the market place.