William O’Neil’s How to Make in Stocks 2: CAN-SLIM’s “C”

This time marks the second installment of William O’Neil’s growth stock discovery series. For those who missed the first installment, please be sure to read it by following the link below:

William O’Neil's How to Make in Stocks 1: CAN-SLIM

Many authors have written books on growth stock investment, but which methods are you all practicing? I find the approa...

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2024.02.10

I strongly recommend purchasing the book to delve into the details of Mr. William O’Neil’s investment methodology and thoroughly digesting the content

CAN-SLIM’s “C”: Current Earnings

In the previous article, I mentioned that CAN-SLIM is comprised of seven key investment principles, combining which investors can pursue success in the stock market.

In this second installment of the series, I will delve into the “C” in CAN-SLIM, which stands for “Current Earnings.”

A crucial point in this principle is that investors pay close attention to the trend of earnings over the past few quarters to identify companies demonstrating robust growth. Specifically, investors examine the latest quarterly financial statements of a company to confirm whether profits are increasing.

By doing so, they prioritize companies with sustained growth. If this growth continues, the company is more likely to attract attention in the market and become an appealing choice for investors. The confirmation of growth enhances the expectation of future stock price increases.

When assessing earnings, investors typically look at quarterly EPS (Earnings Per Share) and revenue.

EPS (Earnings per Share)

EPS stands for “Earnings Per Share,” representing the value obtained by dividing a company’s net income by the total number of issued shares. EPS is a key metric for measuring a company’s profitability and serves as a criterion for shareholders to understand the profit per share.

EPS is calculated using the following formula:

EPS = Net Income / Weighted Average Number of Shares Outstanding

Here:

• Net Income represents the total profit of a company after deducting all expenses, taxes, interest, and other costs from its total revenue.
• The Weighted Average Number of Shares Outstanding is a measure that takes into account any changes in the number of outstanding shares during a specific period by applying a weighted average.

A higher EPS indicates that a company’s earnings, on a per-share basis, have increased. This is generally considered a positive sign for investors, as it suggests improved profitability and potential for returns on their investment.

EPS is a crucial metric in evaluating a company’s profitability, and investors often use it in conjunction with other financial indicators and ratios to assess the overall health and performance of a company. It provides valuable insights into the efficiency and success of a company in generating profits for its shareholders. However, it’s essential for investors to consider EPS alongside other financial metrics and factors to gain a comprehensive understanding of a company’s financial situation and prospects.

Identify Stocks with a Significant Increase in Current EPS

William O’Neil suggests that when buying stocks, it is crucial to choose companies with a significant growth rate in EPS for the most recent quarter (the quarter in which the latest financial results are announced) compared to the same quarter of the previous year.

Analyzing the most rapidly growing 600 stocks from 1952 to 2001, it was observed that three out of four stocks that experienced remarkable price increases began this trend right before the quarterly earnings announcements, showing an average EPS increase of over 70%.

Even for companies where EPS growth was not reported in the current quarter, the next quarter demonstrated an average growth rate of 90%.

Looking at stocks that soared from 1910 to 1950, most of them exhibited EPS increases ranging from 40% to 400% before the price surge.

O’Neil emphasizes that there is no need to buy stocks with low EPS, as only a small percentage of listed stocks exhibit such significant EPS increases. Investors are advised to seek exceptional stocks rather than settling for mediocre ones, according to William O’Neil. However, the process of finding such stocks comes with various risks, and it’s essential to learn how to mitigate them.

EPS is considered the most crucial factor in today’s context, and the larger the growth rate, the more favorable it is. In the late 1990s during the Internet boom, despite many companies operating at a loss, only a few like AOL and Yahoo managed to increase their EPS.

Finding exceptional stocks rather than settling for mediocre ones is crucial, according to O’Neil.

Ignore One-Time Special Profits

To become a successful investor, it is crucial not to be misled by temporary earnings. For instance, if a computer manufacturer includes one-time income from the sale of real estate in its earnings per share (EPS) for the previous quarter, this revenue is temporary and does not reflect the company’s sustained profitability.

Earnings derived from such temporary events should be disregarded.

There is historical precedent, such as Citigroup’s involvement in the subprime crisis. Before getting entangled in the crisis due to excessive borrowing, in the 1990s, Citigroup had artificially boosted its EPS by adding temporary income from the sale of commercial real estate.

Being aware of and ignoring these types of temporary gains is essential for investors to make informed decisions based on a company’s genuine and sustainable performance.

Set a Minimum Target for the Increase in Current EPS

Both novice and experienced investors should avoid buying stocks where the EPS for the most recent quarter shows only an 18% to 20% increase compared to the same quarter of the previous year. Successful investors are said to set a minimum target for EPS growth rate at 25% or even 30%, with companies that have achieved significant growth commonly showing EPS increases exceeding these percentages.

To increase the likelihood of success, William O’Neil suggests choosing stocks that have experienced substantial EPS growth in the past two consecutive quarters. In bullish markets, he emphasizes focusing on growth rates of 40% to 500% or more.

Setting higher EPS growth targets is believed to be a strategy for identifying companies with strong and sustained growth potential, aligning with the philosophy that companies showing significant earnings expansion are more likely to attract investor interest and experience positive stock price movements.

Find Companies with Increasing Revenue

William O’Neil emphasizes that even if quarterly EPS is increasing, a minimum condition for consideration is that the revenue has increased by 25% or more in the most recent quarter, or the revenue growth rate has accelerated over the past three quarters.

For new stocks, O’Neil suggests paying attention to those with an average revenue growth rate exceeding 100% over the last 8, 10, or 12 quarters. These stocks are deemed worthy of careful investigation.

Additionally, by incorporating the condition that the current net profit for the most recent quarter is at its highest or near the highest level and that the company ranks among the top in its industry, the success rate in selecting stocks is further enhanced.

Be Cautious If the EPS Growth Rate Decreases for Two Consecutive Quarters

Understanding stocks with increasing quarterly EPS growth rates is important, but equally crucial is recognizing those where the EPS growth rate is decreasing or has significantly decreased.

For instance, if a company that consistently showed 50% earnings growth per quarter suddenly drops to 15%, it may indicate underlying issues, and a cautious approach is advisable before considering a purchase.

However, even excellent companies may experience temporary performance setbacks. Therefore, before determining that a company’s EPS has deteriorated, it’s important to confirm whether there has been a significant decrease in growth rate for two consecutive quarters. A guideline could be looking for a reduction of two-thirds or more compared to the previous growth rate.

Summary

• CAN-SLIM’s “C” refers to “Current Earnings,” a principle that involves closely monitoring the profit trends over the past several quarters to identify companies demonstrating strong growth.
• Specifically, it entails examining the latest quarterly financial statements to confirm whether the company’s earnings are increasing.
• EPS (Earnings Per Share) is a crucial element in this principle, and selecting companies with a significant increase in EPS growth rate is emphasized.
• Successful investors set a minimum target for EPS growth rate and also prioritize revenue.
• Caution is advised for companies where the EPS growth rate is beginning to decrease or has significantly decreased. If a decrease is confirmed for two consecutive quarters, careful consideration is warranted.