An Overview of the CAN SLIM® Investment System
Each
of the letters
represents one
of the seven characteristics of top-performing stocks:
The CAN SLIM® Investment System
Defined
• +25% or more in recent quarters
• +25% or more in each of the past
three
years
Research shows earnings growth is the No. 1 indicator
of a stock’s potential to
make big gains. That’s why it’s important to
look for stocks with strong current results, as
well a history of solid earnings growth.
“There is absolutely no reason for
a stock to go anywhere if the current earnings
are poor.”
-- William
J. O’Neil, Chairman and Founder of Investor’s Business Daily
The Basics
Many people miss
out on the big winners
because they believe they
must get
in on the ground floor. They waste time and money guessing
which cheap stock
will become the next household name.
Research shows that you will have more success by starting your
search a floor or two higher.
Let a stock become institutional quality -- which means it
trades $15 and up with significant daily volume -- and
it’s more likely
to catch the eye of professional investors, like mutual funds and banks. And always let a stock’s earnings
tell you if it’s a winner.
Does that sound like a formula for buying
too late? It isn’t.
Yahoo’s stock price surged 277% in 21 months starting in March 2003. During the four quar- ters
before this big move, Yahoo
offered clues it
would become a winner
when it reported quarterly earnings
growth of 100%, 200%,
400% and 167%. By that fourth
quarter of triple- digit growth, it was as if the stock was
flashing “buy
me” in neon.
Conventional
wisdom
said
those earnings gains were already priced into the stock, and
it
was too
late to buy. But Yahoo was just gearing up.
And was
Yahoo unusual? Not at all.
Our studies of the greatest stock
market
winners
have
shown big gainers reported
huge earnings growth before they began their big run-ups.
Many of these stocks, however,
weren’t well-known names when they launched their runs. For example, Cognizant
Technology Solutions climbed 315% in 91 weeks starting in June
2003. During
the four quarters leading
up to that big move, it logged earnings growth gains
of 41% to 68%. Again, it wasn’t
too late to get in on a leader before that big price move!
Yahoo and Cognizant are not abnormal for the greatest stocks. Rather, they are part of the pattern our
research found regardless of
the time period studied.
We have examined stocks that led the market during various periods as far back
as the
1880s. And we continue to delve into
what’s currently working in the market.
Each study has consistently found that a company’s earnings track record is one of the strongest indicators of
its potential.
Definition: Earnings & Earnings Growth
Earnings -- also called profit or net income --
are what a company makes after paying all its obligations.
Earnings are reported in
two ways: a bottom-line total and a per-share amount. The
per- share figure is calculated by dividing
the total earnings by
the number of shares outstanding.
Earnings can exclude one-time items or include special items, such as the sale
of a plant or the settlement of
a lawsuit. When comparing a company’s earnings
on a year-ago basis, be aware of anything that skews the
comparison.
Quarterly earnings refer to a company’s earnings
during a particular quarter.
Quarterly earnings growth is calculated by
comparing a firm’s quarterly earnings
to its earn- ings during
the same quarter
a year earlier.
For example, if a
company earned 26 cents a share in the first quarter of
2008 and 20 cents a
share
in the first quarter of 2007, it has
a
30% quarterly earnings growth rate.
Annual earnings refer to a company’s earnings
during a particular fiscal year.
Annual earnings growth
compares a firm’s annual earnings to
what it earned during the
pre- vious year.
Acceleration
Helps
Winning stocks often share another
trait: their earnings growth accelerates from quarter to quarter.
For example, if a company’s earnings
rise 20% in the first quarter, 25% in the second quarter and 30% in the third quarter, its earnings growth is accelerating. That means its growing at a faster pace each quarter.
As earnings growth
becomes stronger each quarter, it often attracts the attention of
profes- sional investors like mutual funds, hedge funds, pension funds
and
banks. They are the true
movers of the stock
market
and
they have the
buying power to send a stock’s share price fly- ing.
Earnings Tips
It’s also important to
look at a firm’s earnings in
relation to other
aspects of
its business.
A huge increase in earnings could be the result of a recent merger or acquisition rather than good old-fashioned organic growth. A merger or acquisition is not necessarily a bad thing
— often, it’s the catalyst for plenty of future growth — but it helps to understand why
profit is growing. And that gives
you a better
picture
of the company’s overall health.
Take a look at the firm’s sales growth, as well as its earnings growth.
If sales are sluggish
while earnings surge ahead, that might indicate cost-cutting moves that boost earnings
now, but will disappear when
the company runs out of things to slash.
And don’t
be impressed by a company’s claim of “record
earnings.” The firm’s earnings
could rise
just 1% and it could
still make that
claim. You want to see standout
growth in earn-
ings. So look for quarterly and
yearly increases of
at least 25% -- or higher is even
better.
Key Points
The CAN SLIM® System: Current & Annual
Earnings
Look For:
|
•
|
The best earnings performance now, not just a promise of future earnings.
|
|
|
•
|
Quarterly earnings-per-share growth of at least 25% vs. the same quarter the year
before.
|
|
|
•
|
Preferably, accelerating earnings in recent quarters.
|
|
• Annual earnings-per-share gains of at least 25% in the past three years.
• Firms with EPS Ratings of
80 or higher.
Explosive stock growth doesn’t happen by
accident. The biggest stock
winners
had
new products, new management or
new conditions in an industry
that propelled the company to astounding heights.
That’s why it’s important to
look for the new angle in
a company. The Basics
New Products Ignite Growth
Stocks don’t double, triple or quadruple in a vacuum. There’s
usually
a breakthrough product or service that fuels their advance:
• Syntex rocketed up more than 480% in just six months in 1963, when it developed the
technology behind the birth-control pill.
• McDonald’s surged 1,100% from 1967 to 1971 as its low-cost, fast-food franchising
business model and newly introduced Big Mac burgers swept the nation.
• Shares of stun gun maker Taser climbed more than 2,730% between July 2003 and
April 2004 as police
departments around the
country bought the non-lethal weapon.
For the best companies, success isn’t about luck. It also isn’t about cutting costs and then waiting for “things to turn around.” Rather,
it’s about innovation. As soon as one new product is
introduced, winning companies are working
on the next upgrade or new ways
to sustain
their leadership.
The right leader can make a big difference for a company and
its investors. On
the flip side, inept management can turn a company’s stock
into a laggard.
Sometimes the “new” factor that supercharges a stock is a change in
industry conditions. For example, China’s opening to a more
free economy unleashed a boom that provided a
wide range of new opportunities:
• Commodities: Australian miner BHP Billiton’s sales to China boomed between 2002
and 2005, with China
accounting for 10% of its total sales. By
2007, China sales
made up 20% of the firm’s revenue. Meanwhile, BHP Billiton’s shares soared more
than 500%
between late July 2003 and
early November 2007.
• Shipping: DryShips benefitted as China’s demand for commodities drove up shipping
rates. It came public at $18 a share in
February 2005, then raced up
as high as
$131.34 in less
than
three
years.
• Gambling: In 2004, Las Vegas Sands opened a casino in Macao, a Chinese territory.
By 2006, Macao had passed Las Vegas as the world’s top gambling center. The stock
made its market debut in
late 2004, then
more
than
doubled in price in less than
three years.
New conditions can
generate a powerful wave that can lift the right
stocks to new heights.
Just the
same,
don’t buy a stock
on that metric
alone. Insist on the strongest fundamentals across the board — that includes things like solid earnings growth,
sales growth
and
return on
equity.
New Price Highs Offer
New Opportunities
Some investors pass over a great
stock
because it’s already reaching a new price
high. But that’s precisely the
point where many of the best stocks gain steam and begin
their biggest price
moves!
The greatest stock
winners
of all time had something “new” going on.
Sometimes it was a new product that beat the
competition or a new management team
that infused new goals and direction into the company. And in many
cases, those new price highs were
a sign of what was
to come.
A stock climbing
to new heights can
look risky to some investors. On the flip side,
a stock falling to new lows may look safe.
But appearance is
one thing.
Reality is another.
The best-performing
stocks make new price highs before they make their
major leaps in price. Moreover, stocks at new highs
tend
to continue moving higher, while stocks making new lows tend to continue to
move even lower.
But don’t buy a stock just
because it’s hitting
a new price high.
Make sure it has strong fun- damentals, is part of a strong industry
group, is riding
along with a general market uptrend and is breaking out of a chart base pattern
on strong volume.
The Wrong Path
How many times have you heard the phrase, “buy low, sell high”?
Many investors find it very difficult to abandon that idea. Naturally, everybody likes the idea of getting something
that seems to
be low-priced and a bargain. But
many people also assume it’s too late to buy a stock that’s
already hit an all-time
high, and they’re more comfortable
buying low.
Yet stocks need to
prove themselves to
you and new highs are
a critical hint to the successful investor.
Think about it: If a
stock climbs from $15 to $50, it has to notch
new price highs along the way at $16, $17, $18 and so on. And IBD’s research has found: Stocks making
new highs tend
to go higher.
Stocks plunging to new depths, on
the other hand, can
hit new low after new low.
Trying to guess where the bottom is and buy at the lowest possible price can be like trying to catch a falling
knife: You might luck out and
grab
the handle, but
you’re taking a dangerous
risk.
Your mantra for success means remembering:
“Stocks making new highs tend to go higher — While stocks making new lows tend to go lower.”
For instance, some stocks may have strong fundamentals or great stories, yet they don’t climb
because there’s little interest from large investors. So
while you wait for a stock
to be discovered — if it ever is — other
stocks are moving into
the spotlight.
When a stock is rallying to new 52-week price highs, it’s a sign big institutional
investors are buying shares. And they have the buying power to propel the stock still
higher.
Often, the best is yet to come.
Would you shy away
from a stock
that more than doubled in
the past year
or less? Consider what happened with these stocks:
Coach had a great run in 2002 as its share price
rose
nearly
70%. That was a hefty gain and you might have
thought the stock’s best days
were behind it.
But it still had some energy left. After taking a short
break, Coach resumed its climb
in late February 2003, then went on to gain more than 430% in just over four years.
After its initial public offering in August 2005,
Baidu.com climbed almost 80% in a little
more than two years. Was
it too late to buy at that point?
The China-based Internet company was part of the IBD® 100 in the Sept. 10, 2007 issue of the paper and
its chart was
highlighted with a heavy black border because
the stock was near a buy point. IBD
also had this
insight:
“Near 219.35 buy point after clearing it
on above average vol.”. The stock went on to climb nearly
60%.
Key Points
The CAN SLIM® System: The “New” Factor
Look For:
• New management that can drive a stock to new heights
• New products or
services or new industry conditions can send stocks soaring
• Fundamentally strong stocks making new highs (as they emerge from sound chart
bases on higher volume) are likely to climb
further, while stocks making new lows
often head lower. Therefore, focus on the new price highs list for the best
potential opportunities.
• The great paradox of the stock market is that what seems too high and risky to most
investors is likely
to continue rising. And what seems low and cheap usually
goes lower.
Think of a stock’s price
as a measure of its quality (called “institutional quality”) and, conse- quently,
its potential. Typically, stocks higher in price
reflect higher quality.
The Basics
One of the most basic economic
principles is the law of supply and
demand. And one of the places its
power is most
sharply demonstrated is
in the stock market.
Remember our earlier
discussion of new price highs? The
law of supply and demand is what’s driving those new highs.
Strong demand for a limited
supply of available shares will push a stock’s price up. On the flip side,
an oversupply of
shares and weak demand will cause
the price to sag.
That’s why supply is the S in the CAN SLIM® System.
Daily Trading Volume Is Key
So how do you measure supply and demand? Start with its daily
trading volume.
When a stock’s price climbs sharply, you want to see its daily trading volume
rise as well. That
shows
you that institutional investors like mutual funds and hedge funds are buying in.
If volume is below average, it
tells you big traders aren’t behind the
move and the
stock may not be able
to hold onto
its gains. And
when a stock’s price
drops, you want to see light vol- ume — that tells you there’s no significant
selling
pressure.
But if a stock’s price plunges as its volume
surges higher,
it’s a sign big investors are head- ing for the exits.
And you might want to follow their lead.
This is particularly true if a stock tumbles below
a key moving
average line -- like the 50-day or
200-day -- on heavy volume. As their name implies,
moving
average lines track a stock’s
average price over
a period of time.
Institutional investors will often step in to buy shares of a stock
when
it dips down to one
of its key moving average lines. That’s often to bolster an existing position in
the stock to keep their investment from dropping lower. Their buying power
will, in turn, propel the stock high- er. You frequently see stocks
finding this kind of support at
a key moving average.
Alternatively, if a stock falls
below one of its benchmark moving average lines it’s a sign insti- tutions are
selling — rather
than
buying
— shares.
Key Points
The CAN SLIM® System: Supply & Demand
Look For:
• IBD’s stock tables, online quotes and other tools provide a quick way to assess the
size of demand for
a stock’s shares.
• Volume % Change is
the percent change above — or below
— a stock’s average trad-
ing volume over
the last 50 trading
days. This uncovers companies not yet widely known, but that are experiencing emerging
demand.
• Price increases should be accompanied by increases in volume. That shows you insti-
tutional investors like mutual funds and hedge funds are buying in.
• Price declines should come in lower volume, which tells you there’s no significant sell-
ing pressure.
• If a stock’s price plunges as its volume surges higher, it may be a sign big investors
are heading for the exits.
• Institutional investors will often buy shares when a stock dips to a key moving average
line.
• The Accumulation/Distribution Rating tracks a stock’s supply and demand. Look for
stocks with an A or B Rating.
• 9 •
Leaders: Choosing To Win
In the world of fiction,
the underdog often wins. Unfortunately, it rarely
works that way in investing. Steer clear of stocks that are laggards. In the stock
market, that sad-looking stock at the bottom of the pack
often just falls further
behind the leaders.
But when you choose stocks that have solid
fundamental characteristics — like earnings growth and profit margins —
and are
thriving in the best sectors, your prospects are
better because you are selecting “institutional quality” stocks that get noticed by the biggest traders
— the institutional investors like mutual fund
and pension fund managers.
The Basics
In one of our largest studies of
the greatest stock market
winners
from the early 1950s
through 2000, on average the big winners outperformed 87% of the market before they began their most dramatic price advances.
In a bull market, stocks that are doing the best tend to keep doing well,
while those slumping are likely
to drop further.
Turnaround
candidates exist, but the odds are against them and it can be tough
to pick the right
one.
So a better
strategy is to stick with proven winners
-- companies with CAN SLIM® traits.
Leadership Can Pay Off
A leading company with a cutting-edge product, a
much-needed service, or a company that
comes
from an in-demand industry will pull to the front
of the pack.
• Brought to U.S. shores by an Australian surfer in the 1970s, Ugg sheepskin boots
were rebranded as high-end luxury footwear by Deckers Outdoor in
the mid-
1990s. Then in 2003,
Oprah
Winfrey featured the sheepskin boots on her list of
top holiday gifts. Uggs raked in
$37 million for Deckers that year. Was it
a one-season fad? Hardly.
In fiscal 2007, Ugg boot sales totaled $347.6
million.
By late
2007, Decker’s shares had climbed nearly
700% in just four years.
• Starbucks made its stock market debut June 1992. How far can a coffee-shop concept
take you? In its first eight years on
the market, the stock price jumped more than
1300%.
• Titanium
Metals carved out a niche
for itself by milling
more of the pricey, lightweight metal than any other
U.S. firm. Customers like Boeing and Airbus
use the
titanium it mills to make
more
fuel efficient jets. When the firm’s stock surged in
late January
2005, it had
already climbed more than 80% in the previous 12
months. Was it too late to buy in? Not at all! During the year that
followed, Titanium Metals’
stock climbed
another 460%.
Key Points
The CAN SLIM® System: Leadership
Look For:
• When choosing investment candidates, stick with the leaders. These tend to be firms
with in-demand products or services.
• Steer clear of lagging stocks. They’ll likely remain laggards.
• Don’t overlook a stock simply because its shares have already logged some big gains.
Many of the largest winners
were already outperforming the market when
they
launched their big price
moves.
Big institutional investors, like mutual funds, hedge funds, banks and
insurance companies,
are the driving
force behind much of the trading
activity in the stock market.
And when it comes to
investing, it pays to watch the
pros. Because they have millions - and often
billions - of dollars
to invest, their
decision to buy or sell a stock
can
determine its fate. If they choose to
buy a stock, their increased demand for
its limited supply of
shares can push its
price higher. Conversely, their decision to
unload their holdings can
send its
price tumbling.
The term “institutional sponsorship” refers to the shares of stock owned by
large institutional
investors.
The Basics
Institutional investors make their money buying, holding
and
selling
stocks. They dig deep for information
before they invest
in a company, and once they do, they keep a
close
eye on their investment. Their analysts and researchers study the firms
they put their money into,
meeting with top executives, evaluating industry conditions and gauging the firm’s outlook.
These pros don’t buy a stock — also
known
as taking a position — in one
swift move. That would push the
stock’s price up too quickly.
Instead a fund manager will buy some shares, let the price
settle
down,
and
then
buy more. An institutional investor may spend several
weeks — or even
months — taking a position in a stock.
That’s good news
for individual
investors. If you can learn
to spot the
signs
that institutional investors are buying a stock, you can follow
their lead.
Selling is a bit different. When these large
traders decide to
sell a stock in their portfolio, the process may sometimes be
orderly. But if they choose to
get out quickly
— which in today’s fast-moving news cycle often happens —
a stampede can result.
That’s why as an individual investor, you should sell a stock as it is rising, rather than trying
to pinpoint exactly when it has reached its peak. A
stock will usually flash a series of warning signals when it’s nearing the end of its price run.
Follow the Institutional Footprints
As we mentioned earlier, Institutional investors usually
look for firms with solid earnings and sales track records and
they avoid thinly traded, cheap stocks with spotty histories. That’s because it’s tough for a fund that’s
investing millions of dollars to take a position in a thinly traded, cheap stock
without sending its share price soaring.
Instead, they tend to buy stocks priced at least $15 on the Nasdaq and
at least $20 on the NYSE. They also
opt for stocks that trade at least
300,000
shares a day on average. You should as well.
And keep in mind: Most of the greatest winners start their big price
runs
when
they’re trading at $30 a share and higher. So don’t
be afraid of those higher-priced stocks.
Those are the ones the institutional investors are putting their
money
into — and that’s
what makes a $30 stock
climb to $40, $50 and
more.
Key Points
The CAN SLIM® System: Institutional Sponsorship
Look For:
|
• IBD’s Mutual Funds
& ETFs section regularly
profiles top-rated mutual funds and talks to
their mangers about which stocks they’re buying and selling.
The section includes tables spotlighting top-rated funds which
list the stocks that fund is holding,
buying
and
selling.
To find top-performing mutual
funds,
look at the fund’s
36-Month Performance Rating.
It runs from A+ to E and
appears in the top right
corner of the charts in
the mutual fund sec-
tion. It also runs on Mondays and
Fridays
in IBD’s mutual
fund tables.
Buying a stock during a market downturn can be like trying to swim against the
ocean
tide: You might make some progress,
but the going will be
tough, and a big enough wave of sell- ing could drown you.
That’s because the
majority of stocks tend to follow the market’s general
direction. They’ll
rise if the market is rallying and they’ll fall if it’s in a downturn.
A better strategy is to follow the market’s general flow and make the
trend your
friend. In other words,
buy when the
market’s in an uptrend and sit on the sidelines when it’s working through a correction.
This section will help you learn to size up the health and direction of
the stock market. The Basics
When folks talk about the stock market or the general market, they’re usually referring to one of the four major stock market indexes. These consist of companies from a range of sectors and
industries. Some indexes are made up
of smaller stocks, others are
home
to bigger, more established companies. By watching the
indexes, you’ll get a well-rounded perspective of the overall market:
• The Dow Jones Industrial Average — made up of 30 well established
companies with
large market capitalizations.
• S&P 500 - 500 companies with market capitalizations ranging from more than $400 bil-
lion down to about $1
billion. It’s a broad index, representing a
wide swath of
the economy.
• Nasdaq Composite- Consists of about 3,000 companies from all sectors, but with a
heavy emphasis on
technology firms, as well as newer growth stocks.
• The NYSE Composite which includes more than 2,000 stocks listed on the New York
Stock Exchange. Companies
range from smaller caps to those worth hundreds
of billions of dollars.
It’s also a good idea to keep an eye on other indexes such as the S&P SmallCap 600
- These are 600 smaller companies tracked
within one index.
In addition to the major
indexes, follow IBD’s proprietary indexes. These show
you the perfor- mance of
top growth stocks.
The IBD®
New America Index tracks the stocks of
all companies covered in
The New America
section for six months. The
stocks that comprise this index will change slightly each day, as newly profiled stocks are added, and stocks that we reported on exactly
six months ago are removed. This index gives you an excellent glimpse into the overall performance of
entrepre- neurial firms and companies with products and services that are in heavy demand.
The IBD®
100 index tracks the
performance of stocks in the IBD 100. These are
the top 100 performing companies each week,
sorted by a combination of fundamental and technical strengths. The companies listed on the IBD 100 and
their rankings are revised after the mar- ket close every Friday. The index tracks
the performance of
each
stock for the duration that it remains on
the IBD 100. Once a stock
is removed from the IBD 100, it is no longer
tracked in
the index.
By following the major
indexes, as well as IBD’s own, you’ll
have a greater feel for the types of stocks the market is favoring right
now. Watching their daily price
and
volume
moves will
help you keep your finger on the market’s pulse. The indexes will flash signals when they’re launching a
new rally or when
they’re ready to take
a break.
Interpreting
the stock market’s many nuances is a learned skill. You can
become more
famil-
iar with market timing
by watching Market Wrap Videos each day. IBD
market experts explain the current action,
and
what you should be looking for.
Other sources for market information:
• IBD’s The Big Picture
column gives you a road map to help
size up the stock mar- ket’s daily
action. It also
alerts
you to market-leading stocks that are breaking
out of bases or
breaking down. The column appears daily in the newspaper’s A
section and is available to subscribers at
Investors.com.
• The Market Pulse,
which accompanies The Big Picture column, gives you a quick run down
of the day’s
market
action.
It also tells
you the market’s current
outlook, lists
quality stocks making
big moves and during a rally,
any distribution days that have cropped up.
• During the trading day, IBD’s
market writers post online
updates at Investors.com in the Markets Update column. Updated
multiple times a day, it alerts
readers to leading
stocks that are heading higher or nearing buy points. Its writers
also keep close tabs
on how the major
indexes are faring.
• The Markets Update
column appears in
the Top Stories carousel on the homepage.
During trading hours it also appears in
the IBD Stock Research Tool. In addition, a link
in the IBD Stock Research
Tool makes it easy for
subscribers to include the column in
the My Routine
feature.
Key Points
The CAN SLIM® System: Market Direction
Look For:
• Don’t fight the market’s trend — follow its lead. Buy when the market is in an uptrend
and sit
on the sidelines when it’s working
through a correction.
• The follow-through day occurs sometime after the third day of an attempted rally,
when one of the four major
stock
indexes climbs
sharply one
day and volume
rises from
the previous session.
• Not every follow-through day guarantees a rally — some fail. But no new bull market
has started without one.
A distribution day occurs when one of the major
stock
indexes falls more than 0.2%
in one day on higher volume than the previous session. When the market piles
up four or five dis- tribution days in just a few weeks, and the uptrend seems to have stalled, chances
are it’s heading into a correction.
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