A look at William O'Neil's hallmark CAN SLIM screening approach to finding potential investments in top quality, growing companies.
Created by the legendary investor William J. O'Neil, CAN SLIM is an approach to stock screening that marries technical analysis with fundamental analysis. O'Neal began his investment career in 1958 when he began working as a stock broker for Hayden, Stone & Company; a place where he pioneered an investment strategy which was one of the first to utilize computers. In 1960, O'Neil was accepted to the Harvard Business School's inaugural Program for Management Development, and it is there where his research led him to the idea of the CAN SLIM screening strategy. The program was so successful that it enabled O'Neil to become the top-performing broker in his firm.
In 1963, O'Neil went on to found William O'Neil + Co. Inc., which was the first company to develop a computerized securities database system. He then created Daily Graphs (1972), a weekly publication of stock charts that was sent to subscribers. He founded "O'Neil Data Systems, Inc." (1973), which provides high-speed printing and data-driven publishing and delivery solutions to clients. Then he created Investor's Daily (1984) which, in 1991, became investor's Business Daily, a Web site and print publication which provides free and subscriber based stock research information. In 1998 he launched Daily Graphs Online; and in 2010 he launched MarketSmith, an online stock research tool which is considered to be the next generation of Daily Graphs Online. Throughout his storied career, however, O'Neil's mainstay for stock research has remained CAN SLIM.
CAN-SLIM is an mnemonic which stands for:
- Current Earnings
- Annual Earnings
- New Products or Services
- Supply and Demand
- Leader or Laggard
- Institutional Sponsorship
- Market Indexes
The fundamental and technical analyses components of the seven part CAN SLIM approach can be summarized as follows:
Current earnings: Current quarterly per share earnings should have increased sharply over the same quarter in the previous year, and accelerated earnings seen in recent quarters is viewed as a very positive predictive indicator.
Annual earnings: Annual earnings increases should be seen over the past five years, and annual Returns on Equity (ROE) should be 17% or higher.
New Products or Services: Refers to the idea that those companies that develop new products and/or services will be the ones whose stock prices stand to gain the most.
Supply & Demand: A fundamental law of economics, supply & demand essentially states that a stock's ultimate price will be determined by the overall strength of demand for a company's stock versus the level of supply (i.e. the higher investors' desire to own the stock, and the lower the supply of shares available for purchase, the higher the per share price).
Leaders Over Laggards: O'Neil firmly believes in buying leading stocks in a leading industries. Given that this measurement is more qualitative than quantitative, a stock's Relative Strength Index measurement has been used to more objectively gauge a stock's strength, as compared to those in its peer group.
Institutional Sponsorship: Institutional sponsorship (or ownership) is the fuel that drives stock prices higher. With all of the aforementioned criteria in mind, if an investor can invest in a company's stock prior to its discovery by institutional investors, then that investor stands to gain. If a company's stock is widely owned by institutional investors, then that stock's price has little room for advancement (again, a matter of supply and demand). A quantitative measure here would be the stock's Accumulation/Distribution Rating.
Market Direction: O'Neil prefers investing in stocks when the major indices (i.e. the DOW, S&P 500 and the NASDAQ) are in definite uptrends. In O'Neil's views, rising tides lift all ships, and there is no better time to purchase group leaders than when all (or, at least many) stocks are experiencing price increases.
The primary technical indicator used in the CAN SLIM approach is the Cup & Handle.
Like a good cup of java in the morning, the cup & handle trading pattern is used to determine when a stock is about to begin its day, so to speak. Does it work? Oftentimes - yes - especially when coupled with O'Neil's other CAN SLIM criteria. As one can see in the two charts of McDonald's (NYSE:MCD), if an investor had used O'Neil's CAN SLIM approach and purchased MCD in-and-around the end of May of 2004 (yellow oval - where the end of the handle formed @ $25.00 per share), then he or she, now, would be sitting on a rather tidy, little profit.
O'Neil's CAN SLIM approach to stock investing is not for those who may be "patience challenged." Rather than utilizing a shotgun approach to investing in equities (a.k.a. "diversification), O'Neil's CAN SLIM concept takes more of a sniper's view of hunting for stocks. When his book, "How to Make Money in Stocks: A Winning System in Good Times or Bad," first came out in the mid 90′s, O'Neil's CAN SLIM stock selection method became a big hit. Over the years, however, many investors have found the approach to be a bit inhibitive. In subsequent editions of his book (now in the fourth edition), O'Neil has relaxed several criteria of CAN SLIM to allow for a greater selection of stocks in which to invest.
According to a study performed by the American Institute of Individual Investors (AAII), O'Neil's original CAN SLIM methodology began showing signs of some cracks between December 31, 1997, and February 28, 2013 when the screen was back-tested. According to a recent article entitled: "A CAN SLIM Screen With No Float but Plenty of Lift," which was published by AAII in the Second Quarter 2013 edition of Computer Investing:
While an investment strategy may look good on paper, it must be investable in the real world for it to be useful. If you look at a rolling 12-month average of the number of companies passing the CAN SLIM screen, the results are even more discouraging. Using this 12-month rolling average, the original CAN SLIM screen has had between 17 and only one company meeting the CAN SLIM criteria. Since mid-2007, no more than five companies on average have passed the screen and since the beginning of 2009, no more than two companies have passed on a rolling 12-month basis. Through the end of February, our backtesting period consists of 183 months. During this period, 16 months (9%) had no passing companies; 22 months (12%) had two passing companies; and 16 months (9%) had only three passing companies. That means that, for nearly a third of the months of our backtesting period, three or fewer companies passed the CAN SLIM screen. Having so few stocks pass the screen makes it difficult for an investor to build a diversified portfolio.
This is where many investors may have difficulty with the CAN SLIM approach to investing. Some individual investors feel as though they need to be "in the market" in order to make money; whereas, others would prefer to be in the market as little as possible in order to avoid losses. Unfortunately, however, neither approach is very efficient when it comes to investing. Though utilizing a screening tool that produces few actionable investments can be discouraging, there can be certain advantages to the CAN SLIM approach. Again turning to AAII's report we see that:
This is not to say that having few or no passing companies cannot sometimes be to your advantage. Take for example, the financial crisis of 2008-specifically, the bear market that began in October 2007 and ran through February of 2009. During this period, the S&P 500 lost 52.6% (not including dividends), while the typical AAII stock screen lost over 51%. Over this 17-month period, however, the CAN SLIM screen was out of the market (did not generate a single passing company) eight of those months.
Thus, had an investor relied solely on the CAN SLIM approach for his or her stock selection and investment process, that investor may have been out of the market during one of the nastiest economic periods in history.
During their work, the technical analysts at AAII made adjustments to CAN SLIM's maximum number of shares criteria and found an increase in the number of passing companies the screen produced. In his original study, O'Neil discovered that 95% of the winning stocks had fewer than 25 million shares available for trading; however, he never quantified the maximum number of shares for which to be screened. Based on the third edition of O'Neil's book, AAII developed a revised screen which the author of the study refers to as the "'no float' screen." The screen proved effective at increasing the universe of stocks from which to choose, however, the performance of the new screen proved to be 9.9% less effective at generating returns when compared to O'Neil's original CAN SLIM criteria. As the author of the study states:
Relaxing the criteria has had two significant impacts. First, the overall performance of the revised CAN SLIM screen was lower than that of the original CAN SLIM approach, although it still outperformed the overall market by a strong margin. Since the beginning of 1998, the revised CAN SLIM screen has generated an average annual gain of 14.5%, versus 24.4% for the original CAN SLIM screen. The S&P 500 generated a 2.6% annual price gain over the same time period. On a risk-adjusted basis, the revised CAN SLIM screen has averaged an annual gain of 9.7% through the end of February (versus 14.8% for the original CAN SLIM screen). The second impact of the revised and relaxed criteria is a somewhat larger universe of stocks from which to choose. Between the end of December 1997 and the end of February 2013, the revised CAN SLIM screen averaged eight passing companies a month, an improvement of only one additional company over the original CAN SLIM screen. Looking at the rolling 12-month average, the revised CAN SLIM ranged from 19 to only one passing company. Over the entire backtesing period, the revised CAN SLIM screen was out of the market 14 months, only two less than the original CAN SLIM screen. This, again, helped investors avoid much of the carnage of the 2008 market meltdown. Over the last bear market period, the revised CAN SLIM screen lost 27.8%, faring better than all but four of the AAII stock screens.
Though O'Neil's CAN SLIM approach to investing can prove frustrating, it is a very viable tool for finding good companies in which to invest. Patience is, however, a virtue when it comes to fully utilizing O'Neil's CAN SLIM approach. For those who may be interested in exploring CAN SLIM further, I have included tables which identify passing companies of the various versions of the CAN SLIM screen. They are CANSLIM.xls (O'Neil's original CAN SLIM screen); CANSLIMRev.xls (O'Neil's updated version of CAN SLIM); and CANSLIMNofloat.xls (AAII's version of CAN SLIM).
CAN SLIM Tables:
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.