How to Pick Stocks with CANSLIM

The first rule is selecting stocks that show a major percentage increase in current quarterly earnings per share when compared to the same quarter of the prior year. This is based off of examination of past stock market winners and observation that they all have explosive earnings prior to their big stock moves. Earnings-per-share are calculated by dividing the company's total after-tax profits by the number of common shares outstanding. Quarterly earnings can be found on Google finance or by looking at the EPS rating in Investor's Business Daily.

Current quarterly earnings per share should be up a major percentage -- 25% percent admit to -- over the same quarter the previous year. The best companies which earnings up 100% percent or more.

The second rule is that the company should show an annual earnings increase of 25% to 50% and higher. This shows you a company is not just having a few good quarters but sustained results. O'Neil looks at the past three years of earnings growth and uses that to weed out 80% of the other stocks. To check earnings you can view the company's financial statements on google finance or use the EPS rating in Investor's Business Daily.

Select Stocks 25% a percent higher annual earnings growth rates

"It takes something new to produce startling advance in the price of a stock" says O'Neil in How to Make Money in Stocks. In studies of the greatest stock market winners from 1880 through 2008 more than 95% of them were either a new company or had a new product or new management. These are the driving forces behind a company producing significant growth. To do this research companies product or service once you have identified that it has a good earnings history. Google finance is again good source for information on companies. Beware though of the naysayers opinions that are presented there.
The other part of this rule is a company being at a new high of a properly formed bases. A base is a price pattern on a stocks chart. Learning how to read a chart and identify a correct base is a separate topic which deserves its own attention. See my other lens on chart reading. Another source on chart reading is How to Make Money in Stocks. O'Neil devotes multiple chapters to reading charts, identifying bases and historical examples of companies emerging from bases.

Search for companies that have developed new products or services, or that have benefited from new management or materially improved industry conditions. Then buy their stocks when they are emerging from sound, correctly analyzed price consolidation patterns that are making new price highs on increased volume.

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The price of just about everything in life is determined by the laws of supply and demand and stocks are no different. The supply of a stock is how many shares outstanding it has, or how much stock the company has issued that has not been bought yet. A large capitalization stocks has a lot of stock outstanding, in the billions where as a small capitalization stock has less stock outstanding, in the millions or lower. It is much harder to get a significant price increase on a large capitalization stock because it takes so much trading volume to effect the supply. Where as small capitalization stock can more easily make a big run. The flipside to this is that small capitalization stocks can also make a bigger run in the opposite direction. This is why small-cap stocks are referred to as volatile.
The best way to measure a stocks supply and demand is through its daily trading volume. This shows you how much of the stock is being bought and sold. By looking at a chart and see when there is a big volume increase from prior periods, thus a larger demand. Their are multiple ways to view trading volume. I use the stock tables in Investor's Business Daily beacuse they show the percentage increase in volume from the previous day (they are also sorted by industry, another huge plus discussed later). Some free options are using the charts and portfolio features in Google finance or Investors.com.

"People tend to buy stocks that make you feel either good or comfortable" says O'Neil. However our emotional favorites often turn out to be the dullest stocks. The leader rule is buying a top stock in one of the top industry groups. The top means the one of the best quarterly and annual earnings growth, highest return on equity, widest profit margins, and strongest sales growth. You can compare these figures by finding each one for each company on Google finance. A faster way is to use the relative price strength rating in the Investor's Business Daily stock tables. An RS rating of 99 means that the stocks outperformed 99% of all other companies in terms of price performance. You don't want to buy stock in RS rating of less than 80 and the really big money makers generally have an RS rating of 90 or higher just before they break out.

We talked earlier about how it takes a demand to make a stock's price go up. The biggest source of demand for stocks in large institutions such as mutual funds,pension funds and hedge funds. Institutions like these will make trades anywhere from 1000 to 100,000 shares. These will bring large increases in price and also give the stock more stability as institutions move slower than individual traders. You want to buy stocks that have at least two strong institutional owners and are showing increasing number to owners over several recent quarters. Google finance lists the institutions that own a stock under the ownership section. Subscribers to IBD can check it using the stock checkup feature which will tell you the change in fund ownership and the amount of quarters fund ownership has been increasing.

You can be right about everyone of the previous rules but if you're wrong about the direction of the general market none of them will do you any good. In a bear market three out of four of your stocks plummet on what the market average and you will certainly lose money. Knowing the general market direction is key to being a successful investor. According to O'Neil "the best way for you to determine the direction of the market is to carefully, follow, interpret, and understand the daily charts of the three or four major general market averages and what their price and volume changes are doing on a day-to-day basis." If you're not familiar how to do this don't worry it can be learned with time. The general market refers to the following indexes that your have probably heard at one point or another.
- Standards and poor's 500
- NASDAQ composite
- Dow Jones industrial average
- NYSE composite
You want to learn to identify when the market indexes have topped and when they have bottomed. You can do this by examining the daily price and volume action. The actual details of this are a separate subject. I would again recommend William O'Neil's book How to Make Money in Stocks for learning this. To watch the daily action of these indexes add them to a Google finance portfolio or check the front page of Investor's Business Daily.I read the big picture column on the front page of Investor's Business Daily everyday. This tells you the price and volume change of the market indexes and a brief presentation of the days action. When I am in a rush this and the Leaders up in Volume section are the only thing I read.

You now have a general overview of the CANSLIM method. I highly recommend this method as I have used it myself with great success. It requires you to be involved in your investments but it can reap great rewards. Below are some sources where you can get more information on the CANSLIM method.

- Sign up for free weekly investment advice from William O'Neil at Investor's Quotes Daily

- Read How to Make Money in Stocks

- Start Reading Investor's Business Daily, Get 4 Weeks free when you subscribe the Digital Edition!

-Check out my other squidoo lenses on related topics