Page 276 - How to Make Money in Stocks Trilogy

154 A WINNING SYSTEM

So, if the best stocks had profit increases of this magnitude before they
advanced rapidly in price, why should you settle for anything less? You may
find that only 1% or 2% of stocks listed on Nasdaq or the New York Stock
Exchange show earnings gains of this size. But remember: you’re looking for
stocks that are exceptional, not lackluster. Don’t worry; they’re out there.
As with any search, however, there can be traps and pitfalls along the
way, and you need to know how to avoid them.
The earnings per share (EPS) number you want to focus on is calculated
by dividing a company’s total after-tax profits by the number of common
shares outstanding. This percentage change in EPS is the single most
important element in stock selection today. The greater the percentage
increase, the better.
And yet during the Internet boom of the wild late 1990s, some people
bought stocks based on nothing more than big stories of profits and riches
to come, as most Internet and dot-com companies had shown only deficits
to date. Given that companies such as AOL and Yahoo! were actually show-
ing earnings, risking your hard-earned money in other, unproven stocks was
simply not necessary.
AOL and Yahoo! were the real leaders at that time. When the inevitable
market correction (downturn) hit, lower-grade, more speculative companies
with no earnings rapidly suffered the largest declines. You don’t need that
added risk.
I am continually amazed at how some professional money managers, let
alone individual investors, buy common stocks when the current reported
quarter’s earnings are flat (no change) or down. There is absolutely no good
reason for a stock to go anywhere in a big, sustainable way if its current earn-
ings are poor.
Even profit gains of 5% to 10% are insufficient to fuel a major price
movement in a stock. Besides, a company showing an increase of as little as
8% or 10% is more likely to suddenly report lower or slower earnings the
next quarter.
Unlike some institutional investors such as mutual funds, banks, and
insurance companies, which have billions under management and which
may be restricted by the size of their funds, individual investors have the
luxury of investing in only the very best stocks in each bull cycle. While
some companies with no earnings (like Amazon.com and Priceline.com)
had big moves in their stocks in 1998–1999, most investors in that time
period would have been better off buying stocks like America Online and
Charles Schwab, both of which had strong earnings.
Following the CAN SLIM strategy’s emphasis on earnings ensures that
an investor will always be led to the strongest stocks in any market cycle,