The CAN SLIM Approach: Revising a Screen
The CAN SLIM system has been popular with our members for a long time as a growth approach for selecting and managing a portfolio of stocks. The CAN SLIM approach is presented by William O'Neil in his book titled "How to Make Money in Stocks: A Winning System in Good Times or Bad," (Mc-Graw Hill, third edition, 2002). O'Neil developed the approach by studying the characteristics common to 600 of the biggest winning stocks from the 1950s through 2001. The rules of the system are based upon the fundamental and technical factors of these winners before they had their big price increases. O'Neil also founded Investor's Business Daily, a financial newspaper that presents stock and market information consistent with the CAN SLIM system.
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- C = Current Quarterly Earnings
- A = Annual Earnings Increases
- N = New Products, New Management, New Highs
- S = Supply and Demand
- L = Leader or Laggard
- I = Institutional Sponsorship
- M = Market Direction
- Screening Results
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The approach seeks out companies with a proven record of earnings and sales growth that are showing strong relative price strength and support from leading institutions. O'Neil does not mind paying rich premiums for such stocks with good prospects, and takes the stand that most stocks with low price-earnings ratios are probably priced correctly by the market. O'Neil believes that it is important to follow the market closely and try to lighten up your stock exposure when going into a bear market.
O'Neil modified the approach in the third edition of "How to Make Money in Stocks"; the April 2003 issue of the AAII Journal discusses these changes and presents the CAN SLIM system in greater detail. In this article, we will briefly present how to apply the CAN SLIM stock screen using the top stock screeners identified in the November/December 2002 issue of Computerized Investing, CNBC at MSN Money by Microsoft (top Web pick), ProSearch by Wall Street City (top pick for Mac) and Stock Investor Pro by AAII (top pick for Windows).
C = Current Quarterly Earnings
The CAN SLIM approach focuses on companies with proven records of earnings growth that are still in a stage of earnings acceleration. O'Neil's study of winning stocks highlighted that these securities generally had strong quarterly earnings per share performance prior to their significant price run ups. When screening for quarterly earning increases, it is important to compare a quarter to the same quarter last year, i.e., this year's fourth quarter compared to last year's fourth quarter. Many firms have seasonal patterns to their earnings and comparing similar quarters helps to take this into account.
Whenever you are working with earnings, the issue of how to handle extraordinary earnings comes into play. One-time events can distort the actual trend in earnings and make the company performance look better or worse than a comparison against a firm without special charges. O'Neil recommends excluding these non-recurring items from the analysis.
He recommends looking for stocks with a minimum increase in quarterly earnings of 18% to 20% over the same quarterly period one year ago.
This filter was easy to implement with these top three screeners although only Stock Investor Pro distinguished between total earnings per share and earnings per share from continuing operations. All allowed for a filter comparing the growth between the latest reported quarter and the same quarter one year ago.
Beyond looking for strong quarterly growth, O'Neil likes to see an increasing rate of growth. This is so important in the CAN SLIM system that O'Neil warns shareholders to consider selling holdings of companies that show a slowing growth rate two quarters in row. Our next screen specified that the growth rate from the quarter one year ago to the latest quarter be higher than the previous quarte's increase from its counterpart one year prior. Unfortunately, only Stock Investor Pro provided this screening comparison.
As a confirmation of the quarterly earnings screen, O'Neil likes to see same-quarter growth in sales greater than 25%, or at least accelerating from the prior quarter. This screening requirement is new to the third edition of O'Neil's book. All of the screening programs handled this filter easily, and we were able to specify a minimum 25% quarter-over-quarter sales growth rate.
A = Annual Earnings Increases
Winning stocks in O'Neil's study had a steady and significant record of annual earnings in addition to a strong record of current earnings. The primary screen for annual earnings increases that O'Neil uses is the requirement that earnings per share show an increase in each of the last three years. This filter has been loosened slightly from the prior edition of the book, which required earnings increases over each of the last five years.
When applying this screen in Stock Investor Pro, we specified that earnings per share from continuing operations be higher for each year when compared against the previous year. To help guard against any recent reversal in trend, a criterion was included requiring that the earnings over the last 12 months be greater than or equal to earnings from the latest fiscal year.
Neither CNBC at MSN Money nor ProSearch on Wall Street City allowed for year-by-year comparison in their screening engines; however, they supply detailed financials that would allow you to check the year-by-year figures for consistent growth.
O'Neil also recommends screening for companies showing a strong annual earnings growth rate of 25%, or 50% over the last three years.
Stock Investor Pro and ProSearch handled this screen well, but CNBC at MSN Money only supplies a five-year growth rate, which proved to be more restrictive than expected. Further investigation revealed that growth rate calculation methodology differs for the MSN Money system compared to Stock Investor Pro and ProSearch.
The MSN Money growth rate uses a least-squares regression line to determine the rate of growth, while Stock Investor Pro and ProSearch use a geometric average growth rate. The regression calculation on MSN Money tries to take all of the earnings figures over the last five fiscal years into account to determine the growth rate, but requires positive earnings for each data point to calculate its growth rate. The geometric average growth rate, on the other hand, only considers the starting and ending points and can deal with negative starting or ending figures. The MSN Money earnings growth screen proved to be more restrictive because it also required positive earnings for each of the last five years as well as a 25% growth rate.
Optimally the consensus earnings estimate for the next year should be higher than the latest reported year. We added this new screening filter to the Stock Investor Pro screen and MSN Money screen, but could not determine how to add the filter to the ProSearch screening system. ProSearch provides all of the data, so a manual screen can be performed on the passing companies.
Another addition to the CAN SLIM screen is a requirement for high return on equity (ROE). O'Neil's studies show that the greatest winning stocks had ROEs of at least 17%. O'Neil uses this measure to separate well-managed companies from poorly managed ones. All of the screening systems handled this filter without difficulty.
O'Neil feels that a stock needs a catalyst to start a strong price advance. In his study of winning stocks, he found that 95% of the winning stocks had some sort of fundamental spark to push the company ahead of the pack. This catalyst can be a new product or service, a new management team deployed after a period of lackluster performance, or even a structural change in a company's industry, such as a new technology. These are very qualitative factors that do not lend themselves to screening easily.
A second consideration that O'Neil emphasizes is that investors should pursue stocks showing strong upward price movements. O'Neil says that stocks that seem too high-priced and risky most often go even higher, while stocks that seem cheap often go even lower. Stocks that are making the new high list while accompanied by a big increase in volume might be prospects worth checking. A stock making a new high after undergoing a period of price correction and consolidation is especially interesting.
O'Neil's newspaper, Investor's Business Daily, highlights stocks within 10% of their 52-week high; this was the criterion we established for our screen. One would expect many companies to pass during a strong market expansion, while a smaller number of companies would pass during the declining market. All of the top screens were able to handle this filter.
O'Neil emphasized smaller capitalization more strongly in his earlier editions. The third edition states that any size stock can be purchased using the CAN SLIM approach, but smaller companies will be more volatile, with greater pop to the upside and downside. Companies buying back their stock on the open market are preferred, as well as companies with management stock ownership.
No definite screens now come out of the S element of the CAN SLIM system, but if desired you can screen for insider ownership with all of the programs and directly screen for share buyback plans in the MSN Money module.
|Table 1. CAN SLIM Screening Criteria|
C = Current Quarterly Earnings Per Share: The Higher the Better
A = Annual Earnings Increases: Look for Significant Growth
N = New Products, New Management, New Highs: Buy at the Right Time
S = Supply and Demand: Shares Outstanding Plus Big Volume Demand
L = Leader or Laggard: Which Is Your Stock?
I = Institutional Sponsorship: Follow the Leaders
M = Market Direction
O'Neil is not a patient value investor looking for out-of-favor companies and willing to wait for the market to come around to his viewpoint. Rather, he prefers to scan for rapidly growing companies that are market leaders in rapidly expanding industries. O'Neil advocates buying among the best two or three stocks in a group. He feels that you will be compensated for any premium you pay for these leaders with significantly higher rates of return.
O'Neil suggests using relative strength to identify market leaders. Relative strength compares the performance of a stock relative to the market as a whole. Relative strength is reported in many ways and you must be careful to understand how the relative strength figure is used in a given screening system. Companies are often ranked by their relative strength performance and their percentage ranking among all stocks is calculated to show the relative position against other securities. Investor's Business Daily presents the percentage ranking of stocks and O'Neil recommends only looking for stocks with a percentage rank of 80% or greater, stocks that have performed better than 80% of all stocks. This is slightly more stringent than the 70% figure we used when developing our screen from the second edition of his book.
Stock Investor Pro and MSN Money provide a percentile relative strength screening option, so we specified a one-year (last 52 weeks) relative strength rank of 80% or greater. The relative strength figure in ProSearch is a company internal relative strength that indicates the price change of a stock over the last year. The ProSearch screener allows users to screen in a relative mode, so we did not specify a rank figure, only that passing company have as high a value as possible.
Alternatively, if your screening program does not present the percentage ranking of stocks, then you could establish a cut-off value for a criterion so that only a certain percentage of stocks pass the filter.
O'Neil feels that a stock needs a few institutional sponsors for it to show above-market performance. Three to 10 institutional owners are suggested as a reasonable minimum number. This number refers to actual institutional owners of the common stock, not institutional analysts tracking and providing earnings estimates on stocks.
Beyond looking for a minimum number of institutional owners, O'Neil suggests that investors look at the recent record of the institutions. The analysis of the holdings of successful mutual funds represent a good resource for the investor because of the widely distributed information on mutual funds. Morningstar.com and CNBC at MSN Money disclose the top mutual funds that own a given stock.
We screened for a minimum of 10 institutional shareholders within Stock Investor Pro and ProSearch on Wall Street City, but had to use a substitute for MSN Money. MSN Money allows you to screen for the percentage of shares held by institutions, but not the number of institutions. With MSN Money, we screened for stocks that had at least 5% of their outstanding shares held by institutions.
O'Neil also likes to see the number of institutional shareholders increasing for a given stock in the most recent quarters. ProSearch did not allow us to screen for this factor, but MSN Money allows the user to screen for increasing institutional ownership for a number of time periods. Stock Investor Pro reports on the number of shares sold and purchased by institutions over the last quarter, so we specified that the number of shares purchased be greater than the number of shares sold over the last quarter.
The final aspect of the CAN SLIM system looks at the overall market direction. While it does not impact the selection of specific stocks, the trend of the overall market will have a tremendous impact on the performance of your portfolio. O'Neil tends to focus on technical measures when determining the overall direction of the marketplace. Any good technical program or Web site (see comparison in this issue), or even a newspaper such as Investor's Business Daily, should provide you with the necessary tools to study market movement.
O'Neil finds it difficult to fight the trend, so it is important to determine if you are in a bull or bear market. If you are selecting your own stocks, O'Neil feels that it is important to follow and understand what the general market averages are doing every day. When the market peaks and begins a major reversal, O'Neil emphasizes that you should try to put some of your portfolio into cash. It is important that you act quickly, especially if you have purchased your stocks on margin.
Other attractive items at a market top include heavy volume without significant price progress and the divergence of key averages. At market tops you will often find past market leaders faltering, while poor-quality stocks are showing up on the most-active lists.
When the market starts down, it sometimes takes time for the volume to build. O'Neil warns that the market can be slow to acknowledge the downtrend.
The figures shown here display the screening criteria and screening results. While there is some overlap of passing companies, different companies passed each screening system due to unique data, calculation methodology, and screening capabilities. Nevertheless, each screener captured the basic essence of the CAN SLIM system, identifying growth companies with strong price momentum and an institutional following.
But using the CAN SLIM system does not stop with buying all of the results of a given screen. While the approach is specific, it also stresses the art of investing when analyzing companies highlighted by the approach and interpreting the direction of the market. Any of the top screeners will give you a reasonable starting point for your analysis, but it is important to understand the quantitative and qualitative shortcomings of the screening system you are using. The results from any screen, even one with a strong past record, represents a starting point that requires further analysis before action.
CNBC at MSN Money
Stock Investor Pro
$198 per year
Wall Street City ProSearch
Free to $9.95 per month
John Bajkowski is editor of Computerized Investing and AAII's vice president, financial analysis.