This time marks the third installment in the series on William O’Neil’s growth stock discovery method. If you missed the previous articles, please take a moment to read them by following the link below.
For detailed information on William O’Neil’s investment methodology, I recommend purchasing the book and thoroughly digesting its contents.
CAN-SLIM’s “A”: Annual Earnings Increases
It is common for companies to announce temporarily strong financial results, but that alone is often insufficient to identify breakthrough stocks. To confirm that the latest reports are not temporary and that the company’s quality is high, it’s important to consider the annual EPS growth. Specifically, look for companies that have shown annual EPS growth for the past three consecutive years.
Exclude stocks with a decrease in EPS in the second year and focus on companies that have consistently succeeded over the past several quarters with a substantial increase in EPS. Such companies are more likely to be breakthrough stocks, especially during an upward market trend.
Select Stocks with an Annual EPS Growth Rate of 25-50%
If you’re buying stocks, you should choose those with an annual EPS growth rate of 25%, 50%, or even 100% or more. Even if there is a temporary decrease in the growth rate over a five-year period, a recovery to new high levels in the following year is considered favorable.
Search for Stocks with a High Return On Equity (ROE)
There are two methods to measure the profit and growth of stocks: Return on Equity (ROE) and Earnings Per Share (EPS).
ROE is calculated by dividing the net profit by shareholders’ equity, serving as an indicator of how efficiently a company utilizes its funds.
Almost all stocks that have experienced rapid growth in the past 50 years have shown a minimum of 17% ROE. Notably, the ROE for breakout stocks is often in the range of 25-50%.
Find Companies with Outstanding Annual EPS and Quarterly EPS
To be considered outstanding, a stock should exhibit both recent increases in annual EPS and quarterly EPS. Stocks with a high likelihood of success or those that experience significant growth often emerge when these critical factors align.
For newly public stocks where there may not be a three-year record of EPS, it’s essential to investigate whether there have been substantial increases in EPS over the most recent 5-6 quarters.
However, relying solely on profits for 1-2 quarters is insufficient and may suggest a potential future decline. It’s important to consider sustained growth trends for a more comprehensive evaluation.
Is PER Important?
For many years, analysts considered PER (Price-to-Earnings Ratio) as a fundamental tool for investment decisions. The common belief was that one should buy a stock if it is undervalued (low PER) and sell if it is overvalued (high PER).
However, analyses of breakout stocks from 1880 to the present have shown that PER has little correlation with stock price movements and is not very useful for making buy or sell decisions.
Therefore, assuming that a stock is “undervalued” simply because it has a low PER is considered a misconception. The analysis suggests that what is more crucial in stock selection is the rate of change of EPS.
During the initial stages of the rise of breakout stocks from 1953 to 1985, the average PER was 20 times. Subsequently, these stocks expanded their PER up to 125% during the ascent, reaching an enlargement to 45 times.
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