William J. O’Neil: Inventor of CAN SLIM

William J. O’Neil is a stockbroker, business owner, writer, and successful investor best known for publishing Investor’s Business Daily. He authored multiple books on investing that show the use of his investment formula, CAN SLIM, in action.

While a young stock broker in his 20’s, he studied many different methods to find an investment strategy that would produce satisfactory investment returns for his brokerage clients. None seemed to work consistently so he invented his own called CAN SLIM, which emphasizes buying great companies as their stock prices break out into new highs.

With the success of his investment methods, O’Neill bought a seat on the NYSE at age 30 (at the time the youngest to do so) and founded his own brokerage William O’Neil + Co. His main success came from being an early user of computers to analyze past winning and losing stock investment strategies.

Investment Strategy

Bill O’Neil started his investment research by asking two questions.

O’Neil found his answers through extensive computer based research that showed seven common characteristics to market-beating stocks in the past. O’Neil’s stock investing formula became known as CAN SLIM.

• C = Current Quarterly Earnings Per Share – are there increases?
• A = Annual Earnings – are there increases?
• N = New Products, New Management, New Highs – is there something new propelling the stock higher?
• S = Supply and Demand – is there high volume indicating significant interest in the stock?
• L = Leader or Laggard – is the stock a leader in its industry?
• I = Institutional Sponsorship – are institutions (big investors) supporting the stock?
• M = Market Direction – what is the overall stock market doing?

What to Buy

The CAN SLIM method looks for companies growing earnings at 25% or more and a return on equity greater than 17%. These companies have historically grown the most over future years and tend to be in newer, technology-driven industries.

When to Buy

O’Neil’s research led him to a startling and counter-intuitive conclusion:

The best time to buy a stock is when it is at a new price high.

He found that many commonly used indicators like low price/earnings ratios (P/E) or dividend yields were poor predictors of future price growth. Instead, he would buy fundamentally sound, industry leading companies as their stock price breaks out of a base and into new highs during an up-trending market. O’Neil avoids buying any stock when the broader market is in a decline/correction.

When to Sell

Bill O’Neil recommends always selling a stock if it is showing a 7% to 8% loss regardless of any other factors. His key to long-term successful investing is to avoid losing much money on failed trades but make lots of money on successful ones. He says that you only have to be right half the time to be a successful stock investor.

Selling Short

The average investor should not sell short because short selling takes tremendous skill and timing. Market drops tend to be quick so the window of opportunity is too small for individual investors.

However, for those who want to sell short O’Neil recommends this basic technique: Avoid selling short just because a price looks too high; focus on timing instead.

The best chart pattern to short is one in which a stock breaks out on the upside of its third or fourth base and then fails. The stock should be breaking down toward the low end of its previous base pattern on increased volume.

Pullbacks to failed price bases provide opportunity to short because following a serious price breakdown, there will usually be multiple pullback attempts. Investors at the prior base will be eagar to sell near breakeven to get out of their losing position.

Examples

Home Depot

For about a decade (1990’s) the Home Depot soared over 10x, basically doubling every year in price. It was the leading home improvement supply company during a recovering real estate market that saw broad demand for its products.

Technology Companies

In general Bill O’Neil likes technology companies because they tend to be creating new products and services that cause tremendous growth in earnings. He favors buying the leading technology companies in the leading growth industries during bull markets.

Summary

Like almost all other great investors, Bill O’Neil favored holding only a few winning stocks and cutting losing positions very quickly. He combined lessons from prior great investors he admired such as Bernard Baruch, Jesse Livermore, Gerald M. Loeb, Jack Dreyfus, and Nicolas Darvas with statistical data to create CAN SLIM, his own formula for finding growth stocks. He believed the most serious mistake an investor could make was letting losers run since investment capital declines require twice the losing rate to make up (e.g. it takes a 100% gain to make up for a 50% loss).

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