Globe Investor will be running profiles of prominent investors and exploring their investing strategies in its Investing Heroes series. We started with last week. This week's article profiles William J. O'Neil.
Investment guru William J. O'Neil's resume is an impressive read - at 30, he was the youngest person ever to have a seat on the New York Stock Exchange; his How to Make Money in Stocks is a growth-investing classic, selling more than a million copies; he founded the U.S. brokerage firm William O'Neil + Co., and he also started the business newspaper Investor's Business Daily.
Those successes are largely based on a stock-picking system he designed that identifies stocks that are likely to rise in price and have a high potential for profits, although he gave his system a name -- CANSLIM -- that sounds more like a new diet than a guide to investment success.
Last week, the American Association of Individual Investors named CANSLIM the top-performing investment strategy from 1998 to 2009, which included the recent financial crisis. The non-profit group tracked more than 50 investing methods over 12 years to see how they would fare. CANSLIM returns over the 12 years showed a total gain of 2,763 per cent - compared with the S&P 500's 14.9-per-cent increase. That averages out to about 35.3 per cent a year.
The system is anything but simple, but Mr. O'Neil said in a statement after the AAII results were announced that "it is possible to invest successfully if you are willing to study hard and learn from history."
Learn to Time the Market
Hard work is key (there is a great deal of quantitative analysis involved in picking stocks using this system) - and so, too, is accepting some of Mr. O'Neil's most controversial advice. For example, forget the adage buy low and sell high (it's "completely wrong," he writes) and stop looking for bargains. "What seems too high in price and risky to the majority usually goes higher and what seems low and cheap usually goes lower."
Another contentious point he makes is that individual investors can and should learn to time the market - in fact, the M in CANSLIM is predicated on it.
Mr. O'Neil's first rule for investors has nothing to do with buying stocks. He says that investors must know when to sell and cut their losses.
Investors, he writes in his second book 24 Essential Lessons for Investment Success, "find it gut-wrenching and hard to admit" they were wrong when a stock loses money, but they must overcome that emotion and sell anyway - an essential move if a stock has lost between 7 and 8 per cent from your purchase price.
In fact, the entire CANSLIM system is predicated on taking the emotion out of investing and letting history be your guide.
Here's a brief description of how it works:
C and A are for earnings
Current and annual. Mr. O'Neil writes that the stocks you pick should show a major percentage increase in current quarterly earnings per share - using the most recently reported quarter - when compared to same quarter in the previous year.
The reason for this, he says, is that historically, stocks that begin to soar show a 70-per-cent increase in current earnings before those major advances.
As for annual earnings, Mr. O'Neil believes that annual share-profit growth should be at least 25 per cent for you to consider buying a stock, that next year's consensus estimate should indicate even higher growth -- and that the stock should have grown significantly in each of the past three years.
N is for new
There should be something new in the industry - a new product or service or management. Something that can propel it forward.
S is short for supply and demand
Really, he should have used a V for volume, but CANVLIM wouldn't have the same ring to it. Mr. O'Neil believes you should track the volume of a stock to see whether people are buying or selling it. Also, the larger the number of shares outstanding, the harder it is to budge the stock - to get a really large price increase.
L is leaders and laggards
Pick stocks of companies that lead their industry, not so much in size but in quarterly and annual profit growth and a product that is gaining market share.
I stands for institutions
How is the stock perceived by mutual funds or pension plans? Mr. O'Neil's rule of thumb is that a stock should be in the portfolio of at least 10 institutions, and some of these should be organizations will better-than-average performances.
M is for market direction
Three quarters of stocks follow the market's trend, so it's important to know which way it's headed. His book How to Make Money in Stocks outlines how to time the market using, among other things, daily price and value charts of the key market indexes.
Although CANSLIM is a detailed, somewhat complicated system, like all growth investing it places an emphasis on using earnings as a metric.
"Growth investors do not tend to focus on asset values, they focus primarily on earnings growth potential - future earnings per share," says Prof. Eric Kirzner, a finance professor at the University of Toronto's Rotman School of Management. "And companies whose rate of return on new investment exceeds their cost of capital."
By comparison, value investors concentrate on asset values and on price versus value. "If you look at a good value-investor portfolio, it often has very few, if any technology companies, because technology companies tend to be future-earnings focused and not brick and mortar-type companies."
More on value investing:
Prof. Kirzner also says that growth stocks are often characterized by high price-to-earnings, high price-to-book and high price-to-sales metrics, all of which are the value investor's nightmare.
"Value investors are absolute - the most important criteria is, are you buying the stock at a bargain?" he says.
Howard Lindzon, a Canadian-born entrepreneur who runs the web company StockTwits and manages a hedge fund, is a self-described "big fan" of Mr. O'Neil's. Mr. Lindzon, who is a growth investor, says How to Make Money in Stocks "was one of the first books recommended to me" and he was tremendously influenced by it. He also is an avid reader of Investor's Business Daily, which "helps me to focus in on trends and what stocks I want to own."
His own system for choosing stocks is more of a hybrid, he says, but adds, "I definitely try to own companies that would qualify for CANSLIM."