Earnings Growth Requirements
CANSLIM, like most growth stock investing strategies, depends heavily on earnings growth and acceleration to identify growth stocks worthy of your money. The first two letters of the acronym refer to Current (quarterly) earnings performance and Annual earnings performance.
An important point is that earnings growth should not include one-time, non-recurring income. An example of this would be a manufacturing company selling some property they owned. This non-recurring increase in earnings would distort the true growth in earnings.
Avoid this distortion by using earnings from continuous operations if available in the screener. If not available, you will need to look at the income statement for one-time charges. Better to look for a screener that handles this and save yourself some work.
Another distortion that CANSLIM screens need to avoid is a high growth rate caused by EPS growth from a small base EPS. For example, if a company earns one cent per share in a base period and 10 cents per share in the next period, a growth in earnings of 900% results. Rather than screen for this, examine the base EPS rate of the passing companies.
Other points noted in O’Neil’s book pertaining to earnings:
- The freshness of the data is important. If the quarterly report is past due, run - don’t walk - away.
- Look for at least one other company in this industry doing well.
C – Current Quarterly Earnings
O’Neil found in his study of growth stocks that strong growth in recent earnings performance was key to price performance. This performance is a function of current quarter earnings growth over the same quarter one year ago and must be at least 18%. More is better. Earnings growth in sequential quarters is not as indicative since many companies have seasonal variations and you are not comparing apples to apples.
Quarter over quarter growth of at least 18% is an absolute requirement of CANSLIM – if a screener cannot identify this, it does not qualify.
Accelerating quarterly earnings growth
Equally important to O’Neil is accelerating growth. Not only should the Q over Q growth for the most recent quarter exist, it must be better than the Q over Q growth for the previous quarter. For example, if the current Q over Q growth is 18% and Q over Q growth for the previous quarter is 20%, the company will not pass.
For O’Neil, slowing growth for 2 consecutive quarters is a reason to sell, not to buy.
Some published articles (see Harry Domash’s article in the cited references) do not include this as a pass/fail requirement. We will not demand this in our example implementations either but will note if it is possible.
A – Annual Earnings Increases
Growth in annual earnings must accompany growth in quarterly earnings. The 2nd edition of the book looked for increasing earnings over 5 years with a compound annual growth rate of at least 25% over 4 or 5 years. This is a lot of data and many screeners cannot meet these requirements. A later edition of the book looks for three years of earnings growth rather than five years.
O’Neil would like to see the earnings estimates for the coming year exceed the actual current annual growth. However, since he feels analyst estimates are opinions and not quantitative, this is not a screening requirement but something to consider when examining the results.
Screeners that can meet these requirements are preferred. As a fallback, we will identify screeners that meet CANSLIM “A” requirement suggested by Harry Domash for the MSN Deluxe stock screener. These are:
- Year over year earnings growth >= 25%
- TTM EPS >= $1.00
- Y1 EPS >= $0.50
- ROE for 5 years >= 5%
Earnings growth requirements summary
In summary, the primary screening requirements (where EPS means EPS from continuing operations) are:
- Q5 to Q1 EPS growth >= 18%
- Q5 to Q1 EPS growth > Q6 to Q2 EPS growth
- Q1 EPS > 0
- EPS 5 yr growth >=25%
- EPS TTM >= Y1 EPS
- Y1 EPS > Y2 EPS
- Y2 EPS > Y3 EPS
The secondary screening requirements are:
- Y3 EPS > Y4 EPS
- Y4 EPS > Y5 EPS
NOTE: If 5 year EPS growth is not available, use a shorter time frame.
If all else fails, switch to the Harry Domash requirements for annual growth.
Return to CANSLIM strategy discussion
Bajkowski, John. How to Use the CANSLIM Approach to Screen for Growth Stocks. April 2003. AAII Journal.
Domash, Harry. 7 Signs a Stock is Ready to Soar, January 2004, MSN Money.
O’Neil, William J., How to Make Money in Stocks: A Winning System in Good TImes and BadMcGraw-Hill, Inc. 1995.