The CANSLIM investing strategy relies on 7 criteria to identify high-growth stocks. This article will explain each of these 7 criteria, as well as how to capture them in a CANSLIM stock screener investing method.
What is CANSLIM?
CANSLIM is a growth investing strategy devised by Investor’s Business Daily founder, William J. O’Neil.
Borne out of a study on 500 of the leading stocks from 1953 to 1993, O’Neil developed a stock selection process based on their common traits, and documented it in his book: “How to Make Money in Stocks”.
These boiled down to a combination of fundamental and technical factors that favoured stocks with strong and accelerating earnings growth, bullish stock price momentum, low share count, institutional sponsorship, and positive catalysts.
Stock market direction is also important, as the strategy works best in fast-moving bull markets. This shouldn’t come as a surprise. High growth stocks tend to have higher betas than most other stocks.
The flipside, is that you should tread carefully with this system in bear markets. The biggest winners tend to witness sharp reversals when their fortunes change. As such, O’Neil recommends using stop-losses to limit downside.
Does the CANSLIM Method Work?
While there is limited academic research on the CANSLIM method, many practitioners have backtested their own interpretation of the system and shown impressive results.
I say “their own interpretation”, because there aren’t any hard-and-fast rules that precisely define the CAN SLIM method.
In addition to quantitative criteria, the CANSLIM strategy has numerous qualitative aspects that are subjective and impossible to capture in a backtest or screen.
Therefore, it is best described as an investment philosophy, rather than a mechanical formula like Joel Greenblatt’s magic formula.
Nevertheless, it is hard to ignore the results from these backtests.
For example, AAII’s CANSLIM strategy has outperformed the S&P 500 by an average of 13.3% each year since inception (1998) – leading to a cumulative return of +7543% vs. the S&P’s +300% return.
Understanding the CANSLIM Method
CANSLIM is an acronym, with each letter representing a specific factor or characteristic that O’Neil believes winning stocks possess.
Below is a breakdown of each letter’s meaning…
C – Current Quarterly Earnings
From his study, O’Neil found that winning stocks had strong earnings growth in the current quarter. By this, he meant stocks with significantly higher current quarterly earnings versus the same quarter a year ago.
The minimum threshold he set for this was 20%. In other words, any stock with less than a 20% increase in current quarter earnings versus the same quarter a year ago was excluded from selection.
He also liked to see this earnings growth accompanied by just as strong sales growth, to ensure earnings weren’t purely driven by cost-cutting measures. This wasn’t added until a later edition of his book, so you will see some CANSLIM screens exclude this criteria.
Another late addition to the CANSLIM screening criteria, was accelerating earnings growth in recent quarters, similar to Martin Zweig. Using the year-on-year definition of quarterly earnings growth above, he liked to see this increasing in each of the last 3 quarters.
Lastly, he made sure that at least one other stock in the industry was showing strong quarterly earnings growth to confirm industry strength.
A – Annual Earnings Growth
Now, while current growth is important, it’s no good if it just fizzles out. As such, O’Neil liked to see evidence of longer-term earnings growth, to ensure consistency.
This is where annual earnings growth comes in.
There were 2 things O’Neil liked to see in annual earnings:
- A compounded annual growth rate (CAGR) of at least 25% over the last 5 years
- Positive annual earnings growth in each of the last 3 years
In other words, annual earnings should have increased each year for the last 3 years, and grown, on average, at least 25% for the last 5 years.
N – New Product, Management, or High
N relates to a any new catalyst that generates enthusiasm for a company. This could be a new product or service, a new management team, or even a new high for the share price.
The first 2 of these concern how the business is run from a fundamental standpoint. O’Neil’s study showed that 95% of the best stocks had some tailwind or “story” propelling earnings, and in turn, their share price.
Does the company have a new range of products? A new management team seeking to inject some life into the business? Or is there a new industry trend driving demand?
Essentially, you’re looking for innovative companies that are well run. These are obviously qualitative considerations that are impossible to screen for, but vital nonetheless.
Lastly, stocks hitting new highs on strong volume – particularly after a period of consolidation – were worth keeping an eye on according to O’Neil. The theory being that share price momentum can generate enthusiasm in and of itself, and propel the stock price even higher.
As such, O’Neil added the following criteria to his CANSLIM screen:
Current stock price within 10% of its 52-week high
S – Supply & Demand
S relates to the driving force behind share price movements: supply and demand.
For stock prices to witness large up moves, demand needs to outstrip supply. As such, O’Neil liked companies with a small number of shares outstanding (supply) and increasing trading volume (demand).
In a similar vein, he preferred companies buying back their own stock, or with a large percentage of management ownership (low float), since both of these reduce share supply.
L – Leader or Laggard?
L relates to the competitive position of a stock within in its industry. In other words, is it a leader or a laggard?
O’Neil advocates only owning stocks among the top 2-3 in their industry – preferably a fast-growing one. These quality stocks tend to have a competitive advantage that helps them pull away from their competitors, which gets reflected in share price performance.
By definition, this means avoiding the laggards in the industry, or what he calls “sympathy stocks”. Even if this means paying a premium for the leaders, this is a price worth paying according to O’Neil.
Usually, the process for finding market leaders relies on qualitative and fundamental analysis. However, this requires spending lots of time researching individual companies prospects.
Instead, O’Neil suggests looking at the relative strength of each stock vs the market as a whole. The logic being that stocks outperforming the market (high relative strength) do so for a reason.
To identify market leaders, O’Neil screens for companies with a 52-week relative strength greater than 80% of all stocks.
I – Institutional Sponsorship
When you own a stock, it’s always nice to know that other big investors do too. It gives you a sense of validation.
Therefore, when big spending institutional investors own the same stock as you, this is a good sign. Moreover, if these institutional funds have a strong track record, this is an added bonus, as you know you’re in good company.
This is the essence behind institutional sponsorship.
Essentially, a stock needs a minimum level of institutional ownership to have any credibility according to O’Neil. While different investors debate what this minimum level should be, personally, I think a reasonable threshold is 30%.
Now, while some degree of institutional backing is desirable, you don’t want an excessive amount. Why? Well, if all of the big money is invested, where is the next big share price move going to come from?
To ensure there’s still some upside left in the stock price, you need to leave some room for other big investors to jump on board.
Therefore, your screen should set a maximum level of institutional ownership at 80%.
Peter Lynch was another investor who advocated some, but not too much, institutional ownership.
M – Market Direction
The final component of the CAN SLIM investing system is market direction.
The basic premise here is that you’re more likely to make money in a bull market than a bear market. Kind of obvious, right?
Therefore, O’Neil suggests reducing your exposures when the trend turns against you. No matter how much of an experienced investor you are, it is going to be extremely difficult to make money when the overall market is declining.
Likewise, you should be more aggressive in a bullish market, as your chances of making money are greater.
O’Neil primarily uses technical analysis to spot market direction shifts. For example, he looks at a range of volume and breadth indicators to identify peaks.
He also sets a strict stop-loss limit of 8%. In other words, if you’re down 8% on a position, you should cut your losses.
How to Find CANSLIM Stocks With a Stock Screener
Now we’ve covered the main principles of the CANSLIM method, it’s time to build a stock screening strategy.
For this, we obviously need a stock screener, and in my view, there is none better than Portfolio123.
The great thing about Portfolio123 is that it already has 2 pre-configured CANSLIM screens, which means you can find CANSLIM stocks with a click of a button. ChartMill is another stock screener that has its own CANSLIM settings.
However, I want to show you my own interpretation of the CANSLIM investing system, based on the criteria above.
CANSLIM Stock Screening Criteria
- EPS (excl. extraordinary items) current quarter YoY growth >= 20%
- EPS (excl. extraordinary items) 5-year CAGR >= 25%
- 30% < Institutional Ownership < 80%
- Current Price/52-week high >= 90%
- 52-week share price change >= 80th percentile of all stocks
Now, the astute amongst you will notice I’ve excluded certain details here.
For example, I haven’t included sales growth, despite O’Neil’s emphasis on it. There is also no requirement for the last 3 quarters growth rates to increase sequentially, or the last 3 years’ annual growth rates to be greater than 0.
Remember though, CANSLIM investing isn’t a systematic strategy. Instead, it’s a set of guiding principles to approach active stock selection with.
Just because O’Neil “likes” to see certain characteristics in a stock, it doesn’t mean you have to religiously abide by them. Besides, including all of his criteria in a screen is far too restrictive in my view, and leaves you with very few stocks to conduct further research on – if any!
One way around this is to select a handful of core screening criteria, and apply discretion with any supplementary criteria afterwards.
I’ll show you what I mean…
In the image below, the first 6 rules are what I believe to be the core components of any CANSLIM screen. They get to the heart of the investment philosophy, without imposing too many restrictions.
The last 3 rules, on the other hand, simply provide additional information that I can “eye-ball” at my own discretion. Specifically, they display the last 3 quarters EPS growth rates as columns next to the stock screener results. This way, I can see which stocks (if any) have accelerating EPS growth in recent quarters, without eliminating the vast majority that don’t.
Note, Finviz is another stock screener that lets you input most of this criteria, however it’s not as versatile. Alternatively, Ziggma offers a look inside 13 different “Guru” portfolios for you to take inspiration from.
How to Pick CANSLIM Stocks
The image below shows you what the stock screener results look like.
It’s a list of every stock that meets the screening criteria, with the relevant metrics displayed alongside them.
In particular, you should see the 3 columns I just mentioned: EPSGrQ0, EPSGrQ1, and EPSGrQ2, which display the the year-on-year EPS growth rates for the last 3 quarters.
Hopefully now you can see why I exclude accelerating quarterly EPS growth as a strict constraint. Only 2 stocks satisfy it! (Caterpillar & IBEX). Of course, you can add as many data columns as you like, for example if you want to check sales growth too.
Ok, so now we have a list of potential CANSLIM stocks, how do we pick the right ones?
Of course, nobody shoots perfectly 100% of the time. However, by using a real-world example, I can hopefully show you how to apply the correct line of thinking.
Caterpillar
Caterpillar is interesting, because it’s 1 of only 2 stocks with increasing EPS growth rates in the last 3 quarters: from 2.9%, to 22.39%, to 48.55%. Importantly, current quarter growth (48.55%) is above 20%.
Looking at annual earnings, it also has the highest 5-year CAGR of 155.81%, which shows tremendous longer-term growth.
From a quantitative standpoint, the only area where Caterpillar slightly lets itself down is growth consistency. While long-term earnings growth is strong, there has been some volatility year-to-year.
Remember, O’Neil likes to see positive earnings growth in each of the last 3 years, however as you can see in the graph below, the company had negative EPS growth of -49.1% in fiscal year 2020 (shown as the red line below 0 throughout 2021).
That’s OK though. We’re not looking for perfection.
Moving onto technical analysis, the chart also looks very strong.
It’s close to its all-time highs, and the relative price vs the S&P 500 (red line in top window) has shown impressive strength over the last year. Moreover, it looks as if it’s breaking out of a long-term pennant. This is clearly a market leader according to O’Neil’s definition of relative strength.
Zooming in on the daily chart, you can also see a nice consolidation pattern after a strong rally. To time your entry point, O’Neil suggests buying breakouts from these patterns, particularly if it’s a cup and handle pattern.
What about some of the more qualitative aspects though? Is there anything “new” about the company that might act as a share price catalyst?
Without delving too deep into the micro-analysis, one thing that springs to mind is the structural supply/demand imbalance in the metals industry.
Remember, the “new” catalyst doesn’t have to be stock-specific. It can also relate to an industry trend.
Due to years of underinvestment in mining projects, and the proliferation of metals in electric vehicles and other renewable technologies, the industry finds itself with a shortage of capacity relative to rising demand.
As such, there will likely be a sustained CAPEX cycle in the coming years, which will drive demand for the mining equipment that Caterpillar sells.
If you want to delve deeper into the institutional ownership and supply factors, I recommend using GuruFocus. They provide a useful chart that lets you visualize both of these changing over time.
For instance, in the case of Caterpillar, you can see that institutional ownership rose from a low level of 40% in 2019, to just under 80% today. Interestingly, the stock price rallied significantly over this period. Unfortunately, it also means we’re relatively late to the party now.
The other thing you’ll notice is the blue line steadily decreasing over the last few years. This means the company has been buying back shares and reducing their shares outstanding – a bullish sign.
When to Use the CANSLIM Strategy
As mentioned, the CANSLIM method works best in fast-moving bull markets. This is when sentiment is at its highest, and growth stocks can get a serious wind behind them.
Benefits of the CANSLIM Methodology
Because the CANSLIM methodology is based on the common traits of past winners, it provides investors with a reliable framework to pick stocks.
In other words, by following its rules, we increase our odds of finding stocks with desirable attributes.