CANSLIM Overview
C is for...
Current Quarterly Earnings
Current Quarterly Earnings per Share, says O'Neil, are the "one
key variable (that) stood out from all the rest in importance". In
fact, three out of four of the top 500 stocks from 1953 - 1993
showed earnings increases averaging over 70% in the most recent
quarter. And that was before the stocks exploded in value!
And what about the one in four that didn't? They showed average
increases of 90% in the following quarter.
The name of the game in stocks is clearly earnings, earnings, earnings!
But O'Neil warns that there are pitfalls. Corporations tend to put their best
foot forward in their quarterly reports, and sometimes they can give misleading
information. This is even more true in their press releases. Here are some
pitfalls to avoid:
- Look at Quarterly Earnings per Share, not gross earnings. A
company may have diluted the earnings per share by issuing new stock, which
will not be reflected in a gross earnings report.
- Look at Quarterly
Earnings, not six month or nine month earnings as some companies often
report. If a company reports six or nine month earnings figures, break it
down into quarters and make sure the most recent quarter does not represent
a drop in earnings.
- Omit one time extraordinary gains. Companies sometimes have windfall
profits from the sale of assets. Calculate the earnings after such
non-recurring gains.
Additionally investors should look for accelerating earnings per share. These
are commonly called an "earnings surprise" and are a good sign. Accelerating
earnings virtually always show up prior to a stock's big move according to
O'Neil.
On the other hand, decelerating earnings can spell big trouble. No, the stock
won't necessarily tank. But it can mean "prolonged sideways movement". But
O'Neil says he doesn't turn sour on a stock until it has two quarters of
slowdown as even "the best of organizations can periodically have one slow
quarter".
One tip O'Neil suggests is to consult logarithmic scale rather than
arithmetic scale graphs. Log scales show changes by percentage. The increment
from 1 to 2 ( a 100% increase) is the same as the increment from 2 to 4 (also a
100% increase). The changing slope of the graph created shows whether earnings
(or whatever else you're charting) are accelerating or not. So a stock whose
earnings go from a dollar to two dollars and then to three dollars would show a
slope that starts flattening out in the second quarter rather than continuing in
an un-interrupted straight line.
Finally O'Neil recommends checking other stocks in the same industry. He says
you should be able to find at least one other stock also showing good earnings
growth as a confirming factor. If you can't find one, the earnings growth may be
an anomaly and the trend unsustainable.
How much earnings growth should you look for? O'Neil says at least 18% or
20%. In a bull market you should look for 40% or more.
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