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Sunday, November 30, 2008

Analyzing Stock Before Investing - Value Investing

As sentiments remained negative, investor interest in stock markets waned as indicated by low trading volumes. Investors were unwilling to invest in stocks as they believed the worst was yet to come. Analysts too seem to reinforce the view that the markets will drop even further in 2009.

With valuations of companies falling anywhere between 60-80 percent most companies listed on the NSE and BSE were available very cheap. The only happy investors seemed to be the long-term ones who can now pick and choose their favourite stocks at very low values.

Time to go long-term
Indeed it seems to be the right time for long-term investing. As the famous investors like Jim Rogers and Warren Buffet say, the markets are highly under-valued and are ripe for long-term investments. Many stocks are trading well below their intrinsic values. Smart investing, experts say, especially from an individual standpoint, is where you have the luxury of not having to participate in the market at all times. It also means choosing the most appropriate time to invest when the odds and probabilities of success are highly in your favour. From that perspective, there is no better time than today to invest in stocks as the odds of success are higher now.

So with some perseverance, a lot of research, and the ability to sift through a lot of information, you can find the right company to invest in that will yield supernormal returns over the long term.

One tool that can help in identifying the right company is an investment strategy called CANSLIM. Developed by William O'Neil, the acronym actually stands for a very successful investment strategy. This strategy has been proven and has yield good returns in the past.

So, what is this strategy all about?
CANSLIM consists of seven components. They are mainly quantitative parameters to be applied while selecting any company for investment. Each letter of the word CANSLIM denotes one parameter to be analysed in depth.

They are:

C – Current quarterly earnings per share
It is important to choose stocks that have grown on a quarterly basis. For example, a company's earnings per share (EPS) figures reported in this year's April-June quarter should have grown relative to the EPS figures for that same three-month period of the previous year.

The percentage of growth a company's EPS should grow by is subjective, but the CANSLIM system suggests around 18-20 percent. This suggests that basically all of the high performance stocks show an outstanding quarter-on-quarter growth.

A – Annual earnings per share
These figures should show meaningful growth over the past five years. CANSLIM stresses on the importance of annual earnings' growth. The system indicates that a company should have shown good annual growth (annual EPS) in each of the last five years.

N – New things
The third criterion for a good company is that it has recently undergone a change, which is often necessary for a company to become successful. It could be a new management team, a new product, a new market, or a new high in stock price.

S – Shares outstanding
This should be a small and reasonable number. CANSLIM investors are not looking for older companies with a large capitalisation.

L – Leaders
Buy market leaders and avoid laggards. In each industry, there are always those that lead, providing great gains to shareholders, and those that lag behind In CANSLIM analysis, distinguishing between market leaders and market laggards is of importance.

I – Institutional sponsorship
Buy stocks with at least a few institutional sponsors who have better-than-average recent performance records. Explore all the factors that should be considered when determining whether a company's institutional ownership is of high quality.

M – General market
The market will determine whether you win or lose. So learn how to discern the market's current direction, to interpret the indices (price and volume changes), and actions of the individual market leaders. The final CANSLIM criterion talks about market direction.

When picking stocks, it is important to recognise the type of market. The first two parts of the CANSLIM system are logical steps employing quantitative analysis by identifying a company that has demo strated strong earnings both quarterly and annually. By rigorously following them you have a good basis for a good stock selection.

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