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All-Star Stock Strategy: William O'Neil (CANSLIM)

William O'Neil did not come right out and say the CANSLIM stock-selection strategy he developed is designed to buy high and sell higher. But considering O'Neil's disdain for PE as an analytic tool and his heavy demands when it comes to growth, it's east to see why one might assume he said it. Intellectually speaking, that would outrage many. Interestingly, though, the model we developed based on our application of CANSLIM (with no reference to PE or any other valuation metric) performed quite well, even during bearish periods, enough so to merit a look even by those who usually shun high valuations.

A very demanding model

While O'Neil does not ask for value, it does seem that he's asking for pretty much everything else. Consider the acronym CANSLIM. Without attempting to list everything O'Neil says in How To Make Money In Stocks (2009 Edition), here are some highlights:

C - Current Earnings

Look for strength in current earnings, defined as strong growth rates and a trend of acceleration. Looking at the company in question is obvious. O'Neil also considers other in the same industry, as validation.

A - Annual Earning

Look for strength in annual earnings trends, so you don't wind up with a flash in the pan. But don't focus myopically on EPS. Consider sales trends, earnings stability and quality (i.e. watch out for non-recurring items) and other factors such as margin and return on capital.

N - New Products, New Management, and New Highs

The first two are evident. The third refers to stock prices at new highs. We don's want strong results in isolation. We want them to stem from bona fide catalysts. O'Neil stresses, here, that newness is most likely to come from smaller companies, as opposed to the better known and seemingly safer blue chips, which he sees as more concerned with maintenance rather than growth.

S - Supply and Demand (for the company's shares)

To some extent, this is another variation on the small-company theme. O'Neil likes situations where institutional demand would weigh heavily on the supply of available shares, something that could exert quite a bit of upward price pressure on the stock if things go well for the company.

L - Leader or Laggard? (Guess which O'Neil prefers!)

Look for leadership; companies that are leaders within their industries and whose shares are market leaders.

I - Institutional Sponsorship

This refers to institutional buying, which O'Neil considers important as a driver of upward share price performance.

M - Market Direction (needless to say, we want it to be upward)

While O'Neil considers many factors in connection with individual companies, he also considers the overall market environment and prefers to buy into market strength.

Perhaps the tone of the list can suggest why O'Neil gets away without using a valuation metric. He's looking for very attractive situations, companies that would likely deserve any high valuations we encounter. That's no small matter. Price ratios alone do not make for sensible value investing. There must also be a rational relationship between the quality of the company you buy and the valuation applicable to its shares. O'Neil is clearly aiming high with the latter, so can presumably tolerate high numbers in the former.

The Portfolio123 CANSLIM model

This model reflects the general principles used by Portfolio123 for its All-Star screens (stand-on-their-own models inspired by key elements of the All-Stars' approaches), which can be seen here.

The Portfolio123 CANSLIM model emphasizes strong company growth (in an absolute sense and relative to industry peers) validated by strong industry performance, strong margins and returns on investment, and strong share price performance. Here are the details:

The screen uses the following rules:

Liquidity filter: Universe(foliofn), which means the stock must be tradable in the Folio Investing.com window system; for backtesting purposes, substitute a rule that bars OTC stocks. (Click here for more information)

Eliminate companies classified in the Miscellaneous Financial Services Industry, most of which are investment companies and funds and not the kind of stocks this all-star tended to seek

The percentage of institutional share ownership must rank at least 10% and less than 50% relative to all stocks

The company ranks in the top 35% when it comes to year-to-year EPS growth in the latest quarter

The company ranks in the top 35% when it comes to trailing 12 month EPS growth

The company ranks in the top 50% when it comes to 5-year EPS growth

The company ranks in the top 35% when it comes to share price percent change over the past 240 trading days (approximately one year)

The company ranks in the top 50% when it comes to the current share price divided by the 52-week high

Among the companies that pass the above screen, we select the top 15 based on the O'Neil ranking system, which uses the following large (per the demanding nature of O'Neil's strategy) list of factors:

Company EPS Growth - 25% of total
EPS 3-year growth rate (5% of this category)

Trailing 12 month EPS growth rate (20% of this category)

Latest quarter (year--over-year) EPS growth rate (25% of this category)

EPS 3-year growth rate minus industry average (5% of this category)

Trailing 12 month EPS growth rate minus industry average (20% of this category)

Latest quarter (year--over-year) EPS growth rate minus industry average (25% of this category)

EPS Acceleration - Trailing 12 Months to Latest Quarter (25% of this category)

EPS Acceleration - 3-Years to Trailing 12 Months (25% of this category)
Company Sales Growth - 20% of total
Sales 3-year growth rate (5% of this category)

Trailing 12 month Sales growth rate (20% of this category)

Latest quarter (year--over-year) Sales growth rate (25% of this category)

Sales 3-year growth rate minus industry average (5% of this category)

Trailing 12 month Sales growth rate minus industry average (20% of this category)

Latest quarter (year--over-year) Sales growth rate minus industry average (25% of this category)
Industry EPS Growth - 25% of total
Industry Average EPS 3-year growth rate (10% of this category)

Industry Average Trailing 12 month EPS growth rate (40% of this category)

Industry Average Latest quarter (year--over-year) EPS growth rate (50% of this category)
Market - 15% of total
Share price divided by 52-week high (33.33% of this category)

Institutional Share purchases net of sales (33.33% of this category)

20-day exponentially weighted average stock price divided by 120-day average (33.33% of this category)
Company Quality - 10% of total
Trailing 12 Month Operating Margin ranked relative to all stocks (12.5% of this category)

Trailing 12 Month Operating Margin ranked relative to industry (12.5% of this category)

5-year average Operating Margin ranked relative to all stocks (12.5% of this category)

5-year average Operating Margin ranked relative to industry (12.5% of this category)

Trailing 12 Month Return on Investment ranked relative to all stocks (12.5% of this category)

Trailing 12 Month Return on Investment ranked relative to industry (12.5% of this category)

5-year average Return on Investment ranked relative to all stocks (12.5% of this category)

5-year average Return on Investment ranked relative to industry (12.5% of this category)

Earnings Stability - 5% of total
EPS Stability (50% of this category)

The size of unusual income-statement relative to Sales, lower is better (50% of this category)

Portfolio123 users who would like to examine the details or copy the models for their own use, may do so:

Click here for the O'Neil screen

Click here for the O'Neil ranking system

Backtest results

Figure 1 and Table 1 show the results of a five-year backtest that ran through 1/12/10 which assumes rebalancing every four weeks and selection of the top 15 stocks as per the screen sorted on the basis of the William O'Neil ranking system.

Figure 1


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The material herein, while not guaranteed, is based upon information believed to be reliable and accurate. Neither Prism Financial, Inc., owner of Portfolio123.com, nor Marc H. Gerstein, an independent contractor working with Prism (a) guarantee the accuracy, completeness or timeliness of, or otherwise endorse, the information, views, opinions, or recommendations expressed herein; (b) give investment advice; or (c) advocate the sale or purchase of any security or investment. The material herein is not to be deemed an offer or solicitation on our part with respect to the sale or purchase of any securities. Our writers, contributors, editors and employees may at times have positions in the securities mentioned and may make purchases or sales of these securities while this report is in circulation.

  
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