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CANSLIM Overview

I is for Institutional Sponsorship

This topic is a controversial one because some well know market analysts don't like stocks that are widely held by institutions.

In our chat with Pat McKeough in January 2000, he stated his wariness of both JDS Uniphase and Ballard because they are "just too popular with brokers. Broker favorites get very ugly when they fall out of favour".

Similarly Peter Lynch, in his best-seller "One Up on Wall Street" lists the 13 characteristics of the perfect stock. One of them is "Institutions Don't Own It and the Analysts Don't Follow It".

"When I talk to a company and they tell me the last analyst showed up three years ago," he writes, "I can hardly contain my enthusiasm". And he likes out of favour stocks that "the professionals have abandoned".

William O'Neil, however, argues that "it takes big demand to move supply up, and the largest source of demand for stocks is by far the institutional buyer". And so he has made Institutional Sponsorship the sixth characteristic to look for in winning growth stocks.

Sponsorship by itself, though, is not the be-all and end-all. O'Neil says you should learn to discern "the quality of sponsorship". Look for sponsorship by savvy institutions with strong track records.

It is important to note that sponsorship does not mean the stock is followed by some newsletter writers or included in some brokerage research reports. It means the stock is included in the portfolios of mutual funds, pension funds, insurance companies, and other large institutions.

If a stock has no sponsorship, argues O'Neil, it's a good bet that some have looked at the stock and rejected it.

Too Much is Not a Good Thing

But you can have too much of a good thing. O'Neil also hedges his bets and agrees with Lynch and McKeough that excessive institutional ownership is dangerous. If something goes wrong with a company and all the mutual funds holding it sell en masse, the stock will tank big time.

How much is too much? O'Neil says the top fifty stocks owned by institutions are often poor performers and rather risky. By the time every institution has some, the stock may well have peaked. He cites the case of Xerox in 1974. Every mutual fund was buying it. The stock tumbled in spite of that.

Again, it all comes down to the quality of buying. In a nutshell, "buy stocks that have at least a few institutional sponsors with better-than-average recent performance records".

Finding Out About Sponsorship

So how can we find out whether a stock has some sponsorship and by whom?

One way to see if a stock has some institutional support is by checking its trading activity for "block trades". A block trade is a single trade of a large number of shares. The TSX defines it as a trade of 10,000 shares or more and having a value of at least $100,000. Typically, only an institutional investor has the money to buy such blocks.

However, only one side to the trade needs to be buying or selling the block. A mutual fund could be dumping a block of shares which is sold piecemeal to many small investors. So it is important that the block is bought, not sold. You can often tell whether it is a block being bought or sold by the price action. If the trade involves an uptick in price, it is usually a block being bought. If it is a downtick, it is usually a block being sold.

One source of information on institutional holdings is to go to a mutual fund website and see what the funds you regard as being top performers have as their top ten holdings. You can check out individual fund company websites as well.

Morningstar and other websites focusing on mutual funds publish what funds are holding any particular security and in what amount. Sometimes these are subscription services.

Of course, the easiest way to find out if a company has some institutional sponsorship is to just ask it. Visit Edgar or Sedar,  look up the company, and email them, asking if any of their shares are held by mutual funds, pension funds or other institutional investors. They should be able to tell you which institutions are their major shareholders.

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