One of the first investing books I read was by author William J. O’Neil titled, "How to Make Money in Stocks", which outlined the CAN SLIM system. My trading has changed greatly from those days, but I still have a fondness for my first fundamental/technical trading strategy. For those of you unfamiliar with this approach – it essentially looks for exciting high-growth stocks with accelerating earnings in a bull market making technical price breakouts.
How good of a system is it? One problem in tracking performance of the CAN SLIM method (and most other strategies) stems from a system being part quantitative and part qualitative - and this is compounded by some of the trading rules being subject to interpretation (something 'new' about a company). Two sites attempt to track performance of this system – but their methods differ. After a quick examination of both, we will investigate how a combination of two methods (including one of my own) may yield even better results than the websites report.
American Association of Individual Investors
American Association of Individual Investors attempts to mimic CAN SLIM through an absolute rule-based system. A sampling of these 'absolute rules' are:
- Quarter growth over 20%
- 5 year earnings growth over 25%
Using a monthly re-balancing technique since 1998 results in a reported 28.3% annualized return (according to AAII.com).
A slightly different approach is used at Portfolio123. They prefer to use ranking rules and relative filtering rules instead of absolute ones. Examples of these 'relative rules' are as follows:
- EPS growth (latest qtr) Percentile rank in top 35%
- EPS growth (5 years) Percentile rank in top 35%
Using a monthly rebalancing technique since April 2001 (this is when provided data begins) results in a reported 21.07% compound annual growth rate. It would appear that AAII's approach is better, but they also don't allow you to inspect the generated picks at different points in time.
What if we mixed the two approaches that uses some relative ranking rules and some absolute? Would these two different styles complement each other for improved results or would they clash?
The following rules will be used to combine absolute and relative high-growth trading rules:
- 95/100 or better with P123 O’Neil relative ranking system
- Earnings: quarterly, trailing 12 months, and 5 year growth is in top 35% of the market
- Quarterly earnings growth is at least 20%
- Float < 20 million shares
- Top 50% of 52 week relative strength
- Price > $1
The result is a whopping 35.09% compound annual growth rate.
Now before you jump up and down in excitement or anger let me add a few realisms. Many of these stocks are illiquid with tiny capitalizations which means wild volatility and big slippage when buying or selling individually. Monthly portfolio re-balancing will erode gains in transaction fees and slippage costs. Many of these companies trade on OTC markets which some investors are not comfortable with. It is unlikely/impossible that you will achieve these posted gains. Adding in 2% slippage (which still is shooting very low) drops the numbers to 28.59% CAGR, and you’ll need to add in trading fees.
There is probably more to discuss on risk, but my point was to improve upon the CAN SLIM performance as tracked by two sites (but not investors.com). I have made this scan public on Portfolio123 under the screen name CAN SLIM ON STEROIDS. I further added a market timing rule that buys when analyst estimates for the S&P 500 are trending upwards (also included in public scan). This refinement boosts the CAGR up to 38.7%.
Current ‘CAN SLIM on Steroids’ Stock Picks
What can be said of the above stock picks? Keep in mind some of the following points:
- Two-thirds of these stocks have market caps under $100 million. This means high volatility and an increase in risk.
- Over half of the stocks are under $5 which means usually higher retail trading and lower institutional buying.
- Only 20% of the companies listed have an analyst covering the current quarter. Lack of transparency can increase risk and mean more due diligence is required.
- Almost half of the stocks have a current ratio of 2 or higher. These stocks may be small but they have enough liquidity to pay the short-term bills.
- 30% of the companies have no long-term debt.
- High triple-digit quarterly and trailing 12 month growth is the norm.
- These companies are highly illiquid. It may only be suitable for small amounts of capital per company.
- 10 out of the 24 trade on OTC markets.
- If you are a real CAN SLIM lover you may note that VHI is ready to break out on new highs, AETI is marching ever higher with a spurt of volume, and some sloppy cup-and-handle formations exist with some of the others.
This article was not meant to challenge the CAN SLIM approach and the author of this article realizes that any quantitative methods will not be able to mirror what William J. O’Neil does in person. Still, if you like trading high-growth stocks despite their tiny cap and illiquid status, you might find that a modified CAN SLIM screening approach gives a small boost to your annual performance.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.