Authors Larry Swedroe and Andrew Berkin’s book The Incredible Shrinking Alpha’s thesis is largely based on stock picking becoming terrible and getting worse over the years. In an interview, Larry Swedroe the Chief Research Officer in Buckingham Wealth Partners revealed that the abundant information and news available is digested rapidly by an investor. This results in investors being unable to identify underpriced stocks with any regularity.
What Larry said was not wrong. Where investing in the stock market seems lucrative but picking the right stocks has become tricky and difficult these days. With numerous opinions on social media, news, television floating regarding a company’s stock has made investors confused about picking the right one. But, here is one tip for the investors – ‘ Rome was not built in a day’. Therefore, mastering the art of stock picking cannot happen overnight. But a fundamental and technical analysis of stocks can help in picking the right one. One such way is by the CANSLIM method.
What is the CANSLIM method?
CANSLIM is a techno-fundamental strategy founded by an American entrepreneur, stockbroker William O’Neil. This strategy helps to pick quality stocks by focussing on companies that show growth in earnings because of innovation. The strategy suggests buying such stocks before it experiences a major surge.
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According to IBEF (Indian Brand Equity Foundation), the real estate sector is estimated to grow a massive Rs 65000 crore in 2040 from Rs 12000 crore in 2019.
Determining the right stocks using CANSLIM
CANSLIM – is an abbreviation of seven parameters. On analysing those seven parameters we can determine the top-performing stocks in the market.
Let us understand each of these parameters:
Current Earnings of a firm:
Current earnings per share (EPS) of a company should be greater than its previous EPS over the last three quarters. The general rule says companies having a 25 percent growth rate relatively deliver high returns.
Annual Earnings:
The annual earnings of a company for three consecutive years should show a consistent increase to be eligible for pick up. The return on equity should be more than 17 percent for 3 to 5 years.
New product, service, or highs:
A company that brings innovation in products, introduces new services, new leadership practices, new pricing, or condition is identified with positive news. Any positive news makes the stock price go up and stocks of such companies are worth investing in. Without the release of any new products, services, or events, a company’s stock price is likely to depreciate.
Supply and Demand:
Stocks of companies worthy of investing should be scarce in supply backed by high demand. This creates a scenario where the stocks are excessively high in demand that causes a surge in price. Usually, stocks of those companies to be picked up that acquire a portion of their shares improving the EPS and ROE eventually improving investor’s confidence. In short, it looks more financially attractive. A minimum of 25 million shares should be issued to the public.
Leader or Laggard:
Investors should use the indicator relative strength index (RSI) to purchase market-beating stocks. RSI is a momentum indicator that measures the speed and change of price movements. If the RSI value is above 70 it means that the stocks are overbought and if below 30 it signifies oversold. The leading stocks from the leading industries are the optimal stocks to hold.
Institutional sponsorship:
If a stock has a high institutional investor it signifies the condition for the price surge. A company looks promising and signifies the high potential of growth if its institutional investors comprising investment banks, mutual fund firms and pension are taking an interest. Also, those stocks are to be avoided that are over-owned by such investors. There should be at least 10 institutional owners of the shares and the ownership should be 50 percent.
Market direction:
Investors should trade along with the trend. Stocks showing a longer-term uptrend are suitable for investing. For measuring the uptrend, an investor should thoroughly analyse the market movements using the broad market indices, or use a 50-day moving average to confirm a strong uptrend before deciding to invest in a company.
Benefits of using CANSLIM
- It is an appropriate strategy for those investors who cannot hold the stocks for more than 5 or 6 years.
- We often consider investing in such companies that have high P/E ratios, signifying high returns, and tend to overlook the ones with low P/E ratios. But, this low might be for a reason due to investor’s perception of undervaluing it.
Therefore, the P/E ratio might not be the best metric for stock price movement. Instead, look for investing in companies having high-quality businesses with sustainable competitive advantages. In such cases, the CANSLIM helps identify such businesses.
Drawbacks to CANSLIM
- The strategy is suitable for the bullish market where trading volumes are high. The strategy fails to work in a bearish market.
- Investors need to be careful and active while tracking their quarterly performance.
- The strategy is easy to understand but its implementation is difficult. Stocks picked using CANSLIM also bear a high risk as they will be the quickest to drop under a crisis.
Word of advice for the investors
Those investors can invest in stocks using CANSLIM who have a higher risk appetite. The stocks cannot be held for a longer time as much of their price value is parked in for future growth. Investors picking stocks through this strategy will make losses no more than 7-8% below the buy point, but one needs to apply all seven criteria to the stocks interested. Applying only a few will not help in picking the right ones.
