Don’t settle to double your money, look for the next 10-50-100 bagger.
A Strategy to Find The Next Multi-bagger
In case you missed it, we recently put out a video covering an investment approach that, in Paul’s words, “created a wholesale shift” in how he approached investing. This approach is not the buy low and sell high cliché—it’s about thinking differently.
Known by the acronym CANSLIM, this approach comes from the book How to Make Money in Stocks by William O’Neil, the founder of Investor’s Business Daily. We highly recommend you pick up a copy of the book if you don’t already have it. Combined with our various articles on stock picking criteria and approaches, it’ll help set you up to uncover the next multi-bagger.
In the meantime, here’s what you need to know about the CANSLIM approach.
C = Current quarterly earnings
When looking at a stock, we want to see Earnings Per Share (EPS) growing at 25% or higher compared to the same period last year (Q1, etc.)
But make sure to watch out for companies growing through M&A activity or through buying other businesses; while their earnings may be growing at 25% or higher, your share of the earnings may not be due to dilution. Always look at EPS.
A = Annual earnings growth
For an annual basis, you want to see the same thing.
To do this, take the trailing 12 month’s earnings and compare it to the previous 12 months. At the same time, also look for 25% revenue growth as it means there’s a strong chance you’ll see annual earnings growth.
However, note that the more quarterly and annual growth you see the more likely it is other people have discovered it as well. For instance, if you see a company with 10 quarters of back-to-back, 25%+ growth, you may be late to the party. Our cut-off is a minimum two quarters of revenue and earnings growth of 25% or more.
N = New product or service
We always try to find out if there’s a new product, service or initiative that can function as a potential catalyst for growth. The “new” factor is the driver of any acceleration of revenue or earnings, and it’s usually why you see any growth in the smallcap space. Make sure to read up on the company and keep an eye out for any new developments.
S = Supply and demand
To put it simply, you want to see a low supply of shares because this means there’s more potential for upward pressure on the stock price.
Our experience tells us that if a company has less than 50 million shares outstanding, they have a higher chance of becoming profitable than a company with more than 50 million. We believe it’s the case because if you have a management team that’s smart with their shares, they are likely to be good allocators with other resources as well. And the more insider ownership, which is often the case with these low share companies, the lower the supply when the higher the demand comes from when/if a catalyst happens.
As an example, when we first found XPEL, it had 26 million shares outstanding and a $5 million market cap. It now has just 29 million shares outstanding with a $1.5 billion market cap, having gone from 20 cents to around $80.
L = Leader or laggard
You want to constantly be investing in the leader, preferably of a subsector in an industry.
Look for companies that don’t go after a big part of the market; instead, find ones that lead a niche. These are businesses that have 40-50% market share of the niche. This allows them to maintain high margins as there’s little competition and the market is small enough that it doesn’t encourage other larger players to come in and move them out of that space.
I = Institutional sponsorship
Look for a stock that has institutional ownership because this will help drive the capital stewardship of this business and help bring attention to the stock.
However, there’s a catch. While this is good in theory, as institutional support is often verification that the company has the potential to deliver growth, it’s also a bit late. If institutions have bought in, a good portion of the discovery has already happened.
What you really want to do is buy right before institutions do. How do you do this? As we’ve mentioned many times, run the stock through a solid criteria check, including the steps above. If it meets the criteria, it’s only a matter of time before bigger players notice as well.
When it comes to institutional ownership, less is more.
M = Market direction
You’ll do better when the market’s going up. Most investors tend to bail on the way down if they don’t understand what’s happening and if they don’t have strong conviction.
A strong understanding of the market direction will mean that you’ll have higher confidence in the investment you’re buying. You’re able to hold through the ups and downs, with the wider view of what’s going on around you.
And if, like us, you believe that we’re in the initial stages of another bull market for high quality microcaps, you are well-positioned to be looking for good smallcap companies right now.
Putting it all together
While it’s tempting to simplify what value is (“buy low sell high”), you’re infinitely better off replicating what has led to success. It takes a bit of research, but that’s where we come in.
The CANSLIM approach had a huge impact on our overall investing style, and while we have some areas where we differ (e.g., institutional ownership), it’s an overall solid approach that we recommend you add to your toolkit.
It’s also a good time to think about this approach and reflect on your own portfolio. We’re starting to see some companies with exceptional quarterly earnings come out, and while it’s still early, some of these results may hint at a high growth phase ahead.
A recent example is a company we profiled called Inventronics (TSX.V: IVX), which operates a boring business that designs and manufactures metal enclosures. It’s a perfect microcap scenario, where the small retail investor had a massive advantage given it’s size, illiquidity and how undiscovered the business was. At that time, Inventronics was fitting several of the key CANSLIM and Smallcap Discoveries criteria, and despite how terribly the stock market has performed over the past two years, Inventronics has performed exceptionally well increasing by over 20x in just a short two-year timeframe.
But whether we’re on the cusp of another bull run or not, sound investment criteria will almost always ensure you reap the rewards.