Monday, March 27, 2006

CANSLIM Review Part 1

This is a review on the Book "How to make money in stocks" 3rd Edition, by William J O'Neil (ISBN 0-07-137361-6) This review is broken into 8 parts, where each part, I'll focus on the CANSLIM method of chosing the right stock. Hence the focus of this review is only on the first part of the book.

In the first part of the book, O'Neil brings us to the "CANSLIM" formula; "7 chief characteristics of a great stock", as he claims.

1) C: Current quarterly Earnings per Share
2) A: Annual Earnings increases
3) N: New products, new management and new highs in the company
4) S: Supply and Demand
5) L: Leader or Laggard
6) I: Institutional Sponsorship
7) M: Market Direction

I'll start off with the first characteristic.

Current Quarterly Earnings per Share.
This refers to the earnings each share makes every quarter. In other words, it is the EPS for the current quarter. It seems obvious that such a stock is attractive, but there are some points which first need to be considered. Firstly, we need to compare its quarterly earnings with the quarterly earnings of the previous year. This is to eliminate any confusion it might cause on different types of stocks. Some stocks possess an inherent cyclic demand, and might raise and fall according to different "seasons". Such companies, for instance, might be dependant on the price of crude oil, or on other natural resources (eg poultry, rice harvests etc) . Hence we need to compare quarterly earnings this way, not just with consecutive quarters of the same year. Secondly, one should always disregard any one time extraordinary gains. Such gains do not truly affect the growth of the company. An example would be a one time sale of the companies' assets. Such a sale may generate alot of revenue for the company, but yet does not reflect its true growth. Thus it is prudent that whenever we review a companies' EPS, we have to take not on what is happening to the company, and not place overemphasis on crude numbers.

The author notes that besides comparing EPS internally, one should compare them with their competitors' EPS. We will discuss in more detail in the 5th point "L: Leader vs Laggard". For this moment however, let us assume that the company we are focusing on is a leader of the market, and it is having exceptional growth in its current quarter (as compared to last year). But the question remains. How do you define exceptional growth? The author suggests that a minimum of 20% is required. However, in my opinion, it is still up to the investor's discretion whether or not he or she is interested in that particular sector. Even a leader in a particular section might be underperforming because the sector as a whole is not strong. Hence, relatively speaking, even a 100% growth in one company might not make it a good pick because of the sector as a whole. One must take into account many other factors before picking a stock, like in this case, the sector.

If all this seems confusing do not fret. After summarising all of the 7 characteristics, I'll try to apply them to local stocks on the SGX and see how they fair as a whole. This will give a better picture of CANSLIM at work.


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