Many of you saw Bubba Watson win the 2012 Masters in Augusta. It was encouraging to see a golfer with such a unique swing beat the best golfers in the world, most of whom were considered to have superior technique - Bubba never had a golfing lesson in his life but he did work hard on his game.
Investing is no different, there are many different ways to win and over the next few months I will cover a variety of approaches used by successful investors.
Today, I would like to look at the C-A-N-S-L-I-M approach developed by William O’Neil, a famous US investor. His approach to stock selection is set out in detail in his excellent book ‘How to Make Money in Stocks’ and is summarised below.
C = Current Profits
O’Neil recommends choosing stocks whose quarterly profits are growing strongly compared to the comparable prior year period. For example, profits in the January – March 2012 period should be at least 18 per cent greater than the profits in January – March 2011. Although 18-20 per cent growth is a minimum requirement, the truly spectacular performers usually demonstrate profit growth of 50 per cent or more.
A = Annual Profits
The company should have strong profits growth (at least 15 per cent and preferably significantly higher) in each of the last five years . Furthermore, the profit outlook for the next year should be healthy.
N = New
There should be something new about the company or it should recently have undergone change. Whether it is a new product, a new market, a new management team, or a new high in stock price. A classic example of this is Apple following the launch of the iPod.
S = Supply and Demand
O’Neil believed that it was easier for a smaller company stock to show outstanding gains. A minor increase in institutional interest in a small company will have far greater impact on the stock price than for a larger company. So investors should focus on smaller companies - few larger companies would meet his revenue or profits growth criteria anyway.
L = Leader
In each industry, there are companies that lead and generate large gains and those that lag behind, generating mediocre returns at best. A laggard company may seem to have the same product and business model as others in its industry, but do not invest in that company simply because its stock appears cheap. Stocks are generally cheap for a reason. You may pay more now for a market leader, but it will be worth it in the end.
I = Institutional Ownership
O’Neil likes to see three or more institutional investors who have good performance records owning the stock. It is a worrying sign if there is no institutional ownership as this means no professional investors see any merit in the company.
M = Market Direction
It is important that you recognise what type of market you are in – bull or bear. He advised against investing in a bear market as most stocks decline in such a market.
How do you find these wonderful stocks? Through the use of screeners (found on good investment websites) that list companies that meet these criteria. If you can find CANSLIM stocks early in their growth phase, you will do well.