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CAN SLIM : How To Make Money In Stocks

Warning: As I have repeatedly advocated, lay investors SHOULD NOT buy stocks directly. They would do themselves a big favour — and make themselves big money — by sticking to the mutual fund route to equity markets.

However, those adventurous enough to take the plunge, SHOULD NOT depend merely on the (supposedly) hot tips. This is sure to burn their fingers (and money).

Instead, a successful stock-picking strategy coupled with some serious hard work, is strongly recommended.

Among the many ‘not-so-secret’ formulas to riches at the stock markets, CAN SLIM is quite popular and a proven game plan.

CAN SLIM — a process that helps you identify the best shares to buy — was developed by co-founder of Investor's Business Daily Mr. William O'Neil in his book 'How To Make Money In Stocks'.

Here's a brief overview of CAN SLIM, which stands for
C - Current Earnings
A - Annual Earnings
N - New
S - Supply and Demand
L - Leader or Laggard
I - Institutional Sponsorship
M - Market Direction

As you will note, CAN SLIM strategy to pick the best stocks, is a combination of “fundamental” and “technical” factors. While the Fundamentals tell you WHAT to buy (or sell), Technicals tell you WHEN to buy (or sell).

C - Current Earnings
Profits are important and more importantly the profits should be growing.

Recent earnings of the company should show a healthy growth of at least around 18-20% quarter-on-quarter, over the last 3 to 4 quarters. 

Beware! Quality of the earnings reported by the company matters a lot. The numbers should be genuine and not something which may have been manipulated or doctored; or gone up due to one-off events.

Other companies from the same industry, reporting similar uptrend, would add weight to the company’s growth story. 

A - Annual Earnings
Of course, while considering the “short-term” Current Earnings, you can’t ignore the “long-term” annual profitability of the company.

Look for companies with consistent, sustainable profits — and growing at minimum 20-30% year-on-year for at least 3-5 years.

Further, the Return on Equity (ROE) should be 17% or more.

With two of seven parameters devoted to the earnings growth, you will surely appreciate the importance of profits.

N - New
This is the key. 

Most companies, whose shares went on to become multi-baggers, had one thing in common… newness.

New idea, new management, new product / service, new market — there was (nearly) always something novel and innovative happening in the company that brought in the super-normal profits going forward.

Even the “new” highs achieved by a share, often leads to more price appreciation. This being contrary to common sense, O’ Neil describes it as the “stock market’s great paradox”.

Are you picking the right equity shares to buy (or discard)?

S - Supply and Demand
Trading volume — i.e. the Supply and Demand of the company’s shares — is the next crucial factor to be studied.

Naturally! Shares in short supply vis-à-vis demand, have the inherent potential to rise faster.

This is where O’Neil makes another observation, which I would personally advise new investors to preferably avoid. 

O’Neil likes small and medium sized companies. Compared to big corporates, these have smaller capital base and hence limited floating stock. As such, even a small increase in the demand, can dramatically push up their share prices. Caution: Even the fall can be quite precipitous. So be very (very) careful with such stocks.

L - Leader or Laggard
Most industries have a few leaders and many laggards.

As per O’Neil, identify the leaders using the ‘relative price strength’ of their stocks — i.e. the performance of a particular stock vis-à-vis other companies in the industry. CAN SLIM strategy advocates the Relative Price Strength ranking of 70 or more over the previous 12 months.  

Leaders tend to be valued more than the laggards i.e. their PE ratio would be comparatively higher. Obviously! It is the industry leaders who can be expected to deliver the best results at the stock markets.

Therefore, avoid laggards even if they appear cheap based on PE ratio. If various other factors are in favour of the leaders, it may not be a bad idea to buy them even at relatively expensive valuations.  

I - Institutional Sponsorship
Institutional shareholding such as FIIs, Mutual Funds, Insurance Companies etc. is important.

But natural!

None or little shareholding by institutions, indicates that the professional fund managers are not interested. And this happens, only when the company is not investment-worthy. Else, why would hundreds of fund managers not want to own these shares?

However, too much of institutional ownership is also not good. It increases liquidity and trading volume, which can lead to sharp price corrections in case of any bad news.

M - Market Direction
While timing the market is not really important, the fact remains that it helps to understand the market trend. It has been observed that 3/4th of the stocks generally go with the market trends

This would help the investors to at least avoid going against the trend, which is always a difficult period. Despite the potential, the company’s stock may remain subdued for long periods leading to only small gains or even losses.

Most Important End Note
As per O’Neil, put a suitable "profit and loss" plan in place, as soon as you buy the stock (as identified by the CAN SLIM principle). In other words, you should always have stop-loss and stop-gain strategy.

Book a loss as soon as the market price is down by 7-8% of the purchase price… without any exceptions.

Book profits when the price is up by 20%, unless there are possibilities of further gains e.g. in a strong bull market.

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

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