What is William O'Neill's CAN SLIM strategy for picking stocks: its advantages and disadvantages


William O’Neill’s CAN SLIM strategy for picking individual stocks was made famous by Dan Zanger, who turned $10,000 into $18 million in the final 2 years of the dot-com bubble. In this post we are going to look at

  1. What is CAN SLIM
  2. What are its advantages and disadvantages
  3. How we can improve on CAN SLIM’s disadvantages

What is CAN SLIM

CAN SLIM is a a trading strategy for individual stocks. Essentially, the strategy states that you should buy stocks that:

  1. Have strong fundamentals.
  2. Are breaking out from long consolidations.

Each letter of CAN SLIM stands for one thing that stock pickers should look for before buying a stock.

C: Current Quarterly Earnings
Stocks pickers should look for companies that are growing their earnings by at least 25% in the most recent quarter. This cannot be a one-time earnings growth. The stock has to show consistently high earnings growth.
A: Annual Earnings Growth
Like “C”, stock pickers should look for companies that experienced 25%+ annual earnings growth in each of the previous 3-5 years. This ensures that the stock’s earnings growth is not due to one-time events (e.g. a federal tax cut).
*These earnings growth requirements are approximate. It might be 30% when the entire stock market is experiencing strong earnings. It might be 20% when the entire stock market is experiencing weak earnings. The basic idea is that you want to buy stocks with significantly above-average earnings growth.
N: New Product or Service
Stock pickers should look for companies that are innovating or are riding a big trend (e.g. smartphone adoption in the early 2010s). This suggests that the company will continue to experience strong earnings growth in the future.
S: Supply
Stock pickers should look for stocks whose prices rise on increasing volume. This is standard volume analysis for stocks.
L: Leader or Laggard
Stock pickers should look for stocks that are leading their industry. This goes against the idea of “sector rotation”. It states that leading stocks usually continue to lead, and lagging stocks usually continue to lag.
Stocks are placed on a relative price strength scale of 0 to 99. This rank measures the company against its competitors in the same industry. For example, if Amazon has a rank of 85 it means that Amazon has outperformed 85% of tech companies over a specific period of time. The relative price strength scale quantifies “leading/lagging”.
CAN SLIM states that stock pickers should buy stocks with a relative price strength of at least 70 (i.e. have outperformed more than 70% of stocks in their category).
I: Institutional Ownership
Stock pickers should buy stocks that are owned by at least a few institutional investors. Institutional investors (e.g. pension funds) tend to hold stocks for long periods of time.
*Almost all stocks are owned by at least institutional investors nowadays. “I” is mostly irrelevant.
M: Market direction
Stock pickers should buy these stocks when the broad stock market is going up. Even stocks with very strong fundamentals will fall when the broad market goes down. This is where the Medium-Long Term Model becomes useful.

What are its advantages

CAN SLIM combines fundamentals with technicals.
CAN SLIM is an improvement on standard “breakout/breakdown” strategies. There are too many false breakouts nowadays. If the market breaks out, you go long, and the market goes back down, you will lose money on the false breakout. This is called a “bull trap”.
CAN SLIM adds a layer of fundamentals onto “breakout/breakdown” strategies. This increases the probability that a breakout will be a real breakout. The thinking goes:

  1. Stocks that breakout on strong/above-average fundamentals tend to be real breakouts.
  2. Stocks that breakout on weak/below-average fundamentals tend to be false breakouts.

This is logical. Fundamentals are important in the stock market, and a pure technical strategy is mediocre.
CAN SLIM works well in a bull market. It works best in a bubble. 
CAN SLIM is meant to be used during bull markets. It is not meant to be used during bear markets. Remember “M”: Market Direction. Almost all stocks go down during a bear market.
People hear about Dan Zanger’s story and say “gee, this must be the best trading strategy in the world”. But think about it this way. If Dan Zanger turned $10k into $18 million from 1998-2000, wouldn’t he be a billionaire/trillionaire today? He clearly isn’t. This is because CAN SLIM only works really well during a bubble (e.g. the dot-com bubble).
You always want to own the strongest leading stocks in a bubble. These leading stocks tend to lead precisely because they have high earnings growth. It doesn’t matter how “overvalued” these stocks are. Leading stocks tend to get more overvalued AS LONG AS the bubble doesn’t pop.
Dan Zanger basically bought the strongest stocks from 1998-2000. He dumped these stocks on any sign of weakness and rotated into the new leaders. That’s how he churned his portfolio from $10k to $18 million. Leading stocks tend can outperform the broad stock index by multiples during a bubble.
Remember: in a bubble, everyone and their grandmother wants to own the “hot new thing”. That’s why leading stocks continue to outperform until the bubble bursts.
CAN SLIM looks for stocks that are just breaking out
The problem with buying high-momentum stocks is that you might buy at the very top. CAN SLIM tries to get you into the stock’s uptrend when the uptrend still has 2/3 of the way left to go. CAN SLIM states that you should buy a stock when it is just breaking out, not after it has broken out for a long time.
For example, the stock is leading the broad index before breaking out. Once the stock breaks out, the uptrend still has 2/3 left to go. The stock will continue to lead the broad index.

What are its disadvantages

CAN SLIM doesn’t work in a bear market.
Almost all stocks go down in a bear market. CAN SLIM is also mediocre during a choppy bull market. For example, sometimes the “leading/lagging” stocks will switch back and forth every few weeks. In these cases CAN SLIM investors will switch in and out of stocks at the wrong moments.
CAN SLIM is essentially a trend following/breakout strategy. CAN SLIM forces you to cut losses at the wrong times when the stock market’s trend is weak. There are few clear leaders during a choppy bull market, so CAN SLIM doesn’t do that well.
CAN SLIM doesn’t tell you what to do with stocks that have already broken out
CAN SLIM looks to buy stocks that are just on the verge of breaking out. It doesn’t get you into stocks that have already broken out for a long time. Here’s the problem.
Sometimes stocks that have already broken out for a long time will continue to lead the broad stock market for a long time. CAN SLIM makes you miss out on these long opportunities.
Here’s an example with Netflix. Notice how it has led the S&P 500 for many years.

How you can improve on CAN SLIM’s disadvantages

Short the weakest stocks in a bear market
If stocks with strong earnings growth (fundamentals) tend to lead the broad stock market in a bear market, the converse must also be true in a bear market. Stocks with the weakest earnings growth tend to lead the broad market downwards in a bear market.
Hence you can consider shorting stocks that:

  1. Have below-average earnings growth AND
  2. Are on the verge of breaking down below support.

*Shorting the first leg of a bear market is dangerous. You don’t know if it’s the first leg of a bear market or just a correction before the final leg of the bull market.
Go long stocks that have already broken out with a smaller position size
CAN SLIM tells investors to buy stocks that are on the verge of breaking out. CAN SLIM doesn’t want investors to get caught with a high flying stock that’s about to make a correction.
The problem with this is that you don’t really know when a high flying stock will make a correction. An extremely overbought stock can become even more overbought. Growth stock pickers who miss out on these stocks will miss out on large profit opportunities.
You can consider:

  1. Buying stocks with above-average earnings growth (strong fundamentals) AND
  2. Have broken out from a consolidation a long time ago, BUT
  3. Use a smaller-than-normal position size.

This smaller-than-normal position size limits your losses if a correction does indeed begin. A small position will allow you to profit if the high flying stock continues to soar.

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