Uptrend – Dutch Uncles

Confused Over Picking the Right Stocks? Use CANSLIM

Shalmoli Sarkar — Mon, 04 Oct 2021 13:35:09 +0000

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.

The post Confused Over Picking the Right Stocks? Use CANSLIM appeared first on Dutch Uncles.

Decode the Stock Market Trend Using the Dow Way

Shalmoli Sarkar — Thu, 23 Sep 2021 03:35:08 +0000

Technical analysis remains an integral part of the stock market as it is a pictorial representation of price movements that helps investors understand the market reactions. Today, we will find a market analyst using the Japanese candlesticks as a tool to analyse the market, but few know that the foundation of technical analysis was initially laid by Charles Dow.

The Dow theory

The Dow theory was founded by Charles Dow, the creator of the world’s first-ever market index – the Dow Jones Industrial Average (DJIA) – and the father of modern technical analysis. The index was developed with the intent of measuring the movement of the US stocks. Charles Dow was the founder of Dow Jones and Company, and the first editor of the Wall Street Journal.

The theory explains how the stock market can be used by investors to determine the health of the business environment. Dow’s theory was the first to state that the market functions in trends. Though many new market theories and tools have emerged now, the six basic tenets of his theory are still relevant.

How does the Dow theory work?

There are a total of six tenets that form the core of Dow theory’s modern technical analysis

The market discounts all news

The first tenet explains that any external condition such as a new political move, new policies, consumer sentiment, earning announcement by companies, variation in inflation, etc. already is reflected in the price of stocks and indices except for the information on natural calamities. Therefore, investors should not take impulse decisions based on the news and rumours.

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The Dow theory was founded by Charles Dow, the creator of the world’s first-ever market index - the Dow Jones Industrial Average (DJIA) - and the father of modern technical analysis.

The market has three trends namely

Primary trend: It is the major trend that shows how the market progresses in the long term. A primary trend can span many years.
Secondary trend: These are trends that work opposite to the primary trend and are said to be corrections. For example, if the primary trend is moving upward, the secondary trend is downward which can last for a few weeks or months.

3. Minor trends: These are variations to the market movement daily, which last less than 3 weeks and go against the secondary trend. Dow has suggested to not consider minor trends since the fluctuations are a result of market news and rumours.

A trend has three phases

This tenet of Dow theory states that there are three phases to a primary trend that is self-repeating.

Accumulation phase:
This phase occurs after a steep fall in the market over the past 6 months. Investors might be losing hope of any uplift in prices. The accumulation phase occurs when there is a beginning of primary upward or downward trend in a bullish or bearish market. In this phase, institutional investors such as mutual funds, pension funds, and large banks – buy up substantial shares of a given stock. Here, the price forms a base as the shares of stock are accumulated.
Public Participation phase:
In this, the improvement in market conditions and positive sentiments drives more investors to purchase more stocks. It is the longest phase with large price movements.
Distribution phase:
In this phase, the investors sell their stocks anticipating the market decline. In this stage, investors book profits and exit.

Indices should confirm each other

The market behaving bearish and bullish should not be verified by a single index. All the indices should indicate the same. For instance, in the case of bearish trend, Nifty large-cap, Nifty mid-cap, and Nifty small-cap should move in the downward direction. Any deviation in the indices can happen due to speculative or corrective moves.

Trends should be confirmed by volume

An ongoing trend will be confirmed with its trading volume. If the trend is upward, the trading volume rises with a price increase and falls with a price decrease. In a downward trend, the volume of trading should go down with a price decrease. If the trend is downward, the volume increases with a fall in price and decreases with a price rise.

Until there are clear signs of reversals, the trend should continue

One should keep on trading in the ongoing trend unless there are signs of reversals given by technical tools and indicators. Here, the reversal is when the direction of a price trend has changed, from going up to going down, or vice-versa.

Determining trends using Dow theory

Dow always believed that the closing price of stock sets the pace for the trend and not the minor intraday movement. When the trend moves horizontally or sideways, the price varies within a range. Once the range is broken, it can result in greater movements. Till then, the traders should wait for the price movement to break the trend line and should not jump to the conclusion of the trend going upward or downward.

The peak and trough analysis in Dow theory helps to identify trend deviation or reversals. A peak occurs when there is the highest price in the market movement and a trough is the lowest price of a market movement. An upward trend is a series of successively higher peaks and higher troughs. A downward trend is a series of successively lower peaks and lower troughs.

Lastly, every investor must understand the Dow theory to identify the hidden trends and make informed decisions before selling or buying stocks.

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