U.S. equity markets are hovering around all-time highs and stocks are trading at stretched valuations. Picking a winning stock has become more of a conundrum than ever before.
In this market environment, the dilemma is whether an investor can pick a winner based solely on a company’s fundamentals or whether they should be more concerned with technical factors.
Take, for example, Adobe Systems (ticker: ADBE), an American multinational computer software company headquartered in San Jose, California. Adobe transformed from a firm selling boxed software to a cloud subscription model with recurring revenue.
An investor who had bought $10,000 worth of Adobe stock back in 1987 would currently have a portfolio worth more than $6 million. Its prospects remain just as high today. The company recently reported a solid earnings estimate revision and prospects are looking bright for both the short and long term.
So what is the best way to identify the next winning stock like Adobe? Historically, an effective strategy for identifying winning stocks has been the CAN SLIM techno-fundamental methodology developed in the 1950s by a stock broker named William O’Neil. This methodology, combined with screening of corporate insider activity, still has the makings for a winning stock-picking formula.
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The CAN SLIM methodology incorporates seven traits that help investors identify potential winners that have a product, product line or service innovation that results in earnings acceleration. CAN SLIM is also a good indicator of when investors should purchase a stock before the rest of the market finds out about it and its price takes off.
The acronym CAN SLIM recognizes seven criteria to look for when considering a stock purchase:
— C: Current earnings increasing quarter over quarter.
— A: Annual earnings growth that is increasing year over year.
— N: New product/service/management providing catalyst.
— S: Stock price moves supported with increasing volume.
— L: Leading stock in a leading industry.
— I: Institutional ownership by mutual funds increasing.
— M: Market positively trending.
Adobe serves as a great example of the power of CAN SLIM. Naturally, the only way a company could generate a 600 times return is with rapidly growing earnings and a unique and compelling product or service that is in high demand.
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The CAN SLIM methodology that identified Adobe as a “winner” drives the selection criteria for the IBD 50 Index, which has handily beat the S&P 500 since Investor’s Business Daily began tracking it in 2003. The primary driver of the strong performance for the IBD 50 Index is the method by which it seeks to identify growth companies that are likely to be winning stocks, based on earnings, sales, stock performance and other proprietary fundamental and technical factors.
To enhance the CAN SLIM methodology, investors can add an additional screen by keeping a watchful eye on certain-sized insider stock purchases or clusters of executive transactions. There is no one who can know how a company is performing better than its top executives. If the top executive of a company is buying their stock with their own money, it is a great indicator that good things could be in store for investors as well.
Investors can look at the Edgar SEC.gov website, which provides free access to company financial data and more than 21 million filings.
Netflix ( NFLX), which was founded in 1997, is an outstanding example of a combination of insider buying and a great CAN SLIM rank that make for all the hall markings of a winning stock. In 2003, Barry McCarthy, the CFO of Netflix, purchased $98,900 worth of stock at $1.64 per share. Today, with Netflix shares trading at nearly $400 per share, McCarthy’s investment is valued at about $23 million. Not a bad return on investment.
Anyone using the CAN SLIM method in combination with an insider-trading screen would have noticed that McCarthy was buying Netflix stock for a few good reasons. First, the company was growing rapidly. Second, Netflix had built a superior service to Blockbuster Video, the incumbent at the time.
The strong signals from these methodologies continue to support Netflix as a buy. Top executives have been buying the company’s stock, and the company continues to grow year-over-year as well as invest in content for future growth potential.
In June, Bank of America Merrill Lynch raised its price target for Netflix shares, predicting the streaming video giant will have a subscriber base of more than 360 million customers by 2030. The firm also gave a buy rating for the stock, citing the strength of Netflix’s original content library, which is expected to bolster the stock’s pricing power.
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While picking the next winning stock is not an easy task, the opportunity for investors still exists. CAN SLIM methodology has been a proven system for picking winning stocks. CAN SLIM, combined with keeping a watchful eye on executives’ insider purchase transactions, can bring great financial rewards investors looking for the next winning stock.
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How to Identify a Winning Stock originally appeared on usnews.com
