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An excellent introduction to growth stock investing
on September 13, 2009
Along with O'Neil's excellent THE SUCCESSFUL INVESTOR, this book is one of the best introductions to growth stock investing available. He proposes a method (CANSLIM) to discouver what are the best candidates for investment and measure overall market health. BOTH are required for his method to work. The fact that it encourages the use of Investor's Business Daily (IBD) is not a drawback to my mind because market and industry trends change so frequently that you need a daily source of information to keep up with possible CANSLIM candidates. That being said, readers should realize that this method requires that you familiarize yourself with charts and that you be willing to take responsibility for your choices. Not everyone is willing to spend 10-30 minutes a day reading IBD. Many too, prefer to rely on brokers or a guru to make choices because it gives them somebody to blame when there are losses. IBD is useless for such investors.
If I had to summarize the CANSLIM method in a single sentence, I would say that it is a technique that allows individual investors to piggyback on the ebb and flow of institutional money. O'Neil strongly believes that markets rise and fall because of the daily collective decisions of thousands of domestic and foreign financial institutions (mutual funds, banks, insurance companies, hedge funds, etc.) moving billions of dollars around in search of growth. Compared to these corporations, individual retail investor have no influence. Also, institutional investors are much better informed about future trends than you or I can be. It follows, that we as individual investors can greatly reduce the chance element in stock selection by focussing only on institutional-quality companies currently in favour. Avoid penny stocks. Seek the industries whose market price has risen the fastest during the last 6 months. And within these industries, focus only on the "leading" stocks showing the best fundamental (earnings and sales growth, healthy margins, industry-changing new products) and relative strength (upward movement in the last year) scores. Above all, do not avoid stocks because they have risen too much or have high price/earnings ratios. The biggest winners every year, the ones that double and triple, are forever hitting their 52-week highs. So look there and do not waste time with stocks hitting new lows. These "bargains" mostly sink lower and destroy your capital.
A few caveats: assuming the market is not in a bear phase or in correction, O'Neil encourages you to seek for "leaders" with excellent fundamentals that are breaking out of sound bases. Then you must buy in within 5% of their breakout "pivot points" IF their volume is well above average on that day. To help you find these leaders, IBD lists 100 stocks every weekend that satisfy CANSLIM criteria. Some have not yet broken out. Others may be too extended from their most recent breakout. Unfortunately, 10-15% of the IBD 100 are replaced every week. So that in hindsight it is easy to point out how this or that stock did well "because" it was a leader, but there are many many more examples of CANSLIM candidates with excellent bases and fundamentals that suddenly drop large percentages after proper breakouts simply because market psychology has shifted. It follows in hindsight that they were never true leaders. Meanwhile, there are plenty of companies with excellent charts, but questionable fundamentals, that do as well or better than his CANSLIM leaders. This can be very frustrating.
Secondly, for Canadian investors looking for CANSLIM candidates in the TSE, it is well to remember that our heavy reliance on resource stocks means that their fundamentals are often terrible just before they perform best. Resource stocks rise most dramatically when the market perceives that the commodities underlying these stocks are poised to rise in value after a period in the dumps. CANSLIM is therefore a poor guide in this area.
To sum up, CANSLIM works best with young companies offering new products, often in tech industries. That way, their sales, earnings and margins show the steady rise that gives them a high fundamental score in the CANSLIM universe. At the end of the day, however, the market is a maelstrom of fear and hope where fleeting perceptions of future potential far outweigh past fundamentals. CANSLIM can help you narrow your list of choices, but it can also give you a false sense of security until the day where your "leader" suddenly loses favor. CANSLIM leaders are NOT "buy and forget about it" stocks. CANSLIM has nothing to do with Buffett or his methods. If your stock pick drop 8% below your purchase price, you are strongly advised to sell. If it falls below its 50-day moving average after doing well, you are strongly advised to sell and preserve your gains. The point is, you must monitor them and the major indexes on a daily or at least a weekly basis. Leadership is a tricky business.