The “CAN SLIM” System

American businessman William J. O’Neil is one of the greatest investors of our generation. He made a fortune in the market in his twenties, enough for him to buy a seat on the New York Stock Exchange at thirty―the youngest ever to do so at that time. Later, he made even more so that he could quit his job and start his own business. In 1984, O’Neil launched a national business newspaper, Investor’s Business Daily, which competed directly against the formidable Wall Street Journal right from its inception, and had remained a favourite of many investors ever since. His investing strategy, known as “CAN SLIM”, is a top performer according to the American Association of Individual Investors.

His book, How to Make Money in Stocks: A Winning System in Good Times and Bad (O’Neil, 2009, 4ᵗʰ Ed) is a classic which has already sold over two million copies since its first edition published in 1988. The scientific and disciplined approach described in this book, which is supported by research of over a hundred years of stock market data, has inspired generations of traders and investors since then. It is one of the earliest books which blend technical and fundamental factors into one dispassionately objective method of analysis, and provide a complete system with concrete rules for the readers to apply directly in the market.

The first important idea of the book is that one shall rely on history instead of hunches to discover great winners in the market. Many decades ago, when computers were in its infancy, O’Neil hired programmers and statisticians to go over stock market data in the past, in order to find out any common denominator shared by the big winners of the past before they took off. After much blood, toil, tears and sweat, he discovered seven common traits of those winners, which he neatly summarised with the acronym “CAN SLIM”:

1. “C” is for current earnings. Strong growth in earnings must be observed, by at least 18%-20% quarter-over-quarter, while growing sales by 25%.
2. “A” is for annual earnings. Look for companies with stable earnings growth of 25% to 50% annually. The higher, the better. The return on equity should be at least 17%.
3. “N” is for new products, services, management and price highs. Look for something new that serves as a catalyst to boost a stock’s price.
4. “S” is for supply and demand. Look for companies heavily owned by management, buying back their own stock.
5. “L” is for leader or laggard. Opt for the leading players in a leading industry, and avoid laggards in a lagging industry.
6. “I” is for institutional ownership. Buy companies that the leading mutual funds, pension funds, hedge funds and other institutional investors are buying too.
7. “M” is for market in a bullish trend. Three out of four stocks follow the stock market’s overall direction. So you should only buy when the market is rising. Stay on the sidelines when it’s in a correction or bear market.

In summary, the “CAN SLIM” strategy look for companies with enormous growth potential: they shall have innovative products or services that make them the best in their industries: their potential of future growth must be reflected by increasing earnings and sales figures: their shares shall be supported by internal and institutional ownerships; and their share prices must show strength by consistently outperforming the benchmark.

However, knowing what to buy is only a small part of the equation. In order to be successful in the stock market, the next thing that a trader has to know is to recognise the right time to buy, and O’Neil has an unconventional answer. Traditional wisdom advocates that one shall buy low and sell high, which makes a lot of sense on the surface because we all like to buy bargains and sell it back when it recovers, but O’Neil’s research showed that this idea is completely wrong.

O’Neil conducted a study which analysed two groups of companies―those that kept making new-highs in share prices and those making new lows―over many bull market periods. The results were conclusive “What seems too high in price and risky to the majority usually goes higher,” he writes, “and what seems low and cheap usually goes lower.” As a prudent investor, your job is not to buy cheap, but to buy right. “If you had bought Cisco in November of 1990 at the highest price it had ever sold for, when it had just made a new high and looked scary, you would have enjoyed a nearly 75,000% increase from that point forward to its peak in the year 2000.”

In addition, O’Neil also wrote, “If you can’t bring yourself to buy a stock at an all-time high, ask yourself: What does a stock that has traded between $40 and $50 a share over many months, and is now selling at $50, have to do to double in price? Doesn’t it first have to go through $51, then $52, $53, $54, $55, and so on—all new price highs—before it can reach $100?” This is what O’Neil calls the Great Paradox of the Stock Market: if you want to buy right, buy at a new high.

Of course, it does not mean that you can blindly buy a security whenever it touches a new high in price. In the book, O’Neil emphasised that you shall only buy at a new high if the move is accompanied by a reliable consolidation pattern and a sustaintially high volume. The author dedicated more than one chapter for the analyses on chart patterns and volume, i.e. the technical aspects of stock trading. It is suggested that the readers shall read those chapters carefully in order to identify the correct time to buy.

Lastly, one has to know how to exit his position. According to O’Neil’s research, most successful breakouts would not fall more than eight percent below is breakout point, and would stall after rising about twenty-five percent since breakout. Therefore he advocates a three-to-one profit-taking plan, which consists of a seven to eight percent stop-loss, as well as a twenty to twenty-five percent profit target. In this way, you can make money on balance even if you are wrong twice and only correct once. However, there is an important exception to this rule: if the share price rises more than twenty percent within a month after your purchase, you shall hold your position for at least half a year, because it is very likely that you have just bought a true winner which may go a lot further and make enough money to change your life.

David Jacovini, the president of a Philadelphia-based asset management firm, praised the CAN SLIM strategy that it is “partly fundamental, partly technical, but always dispassionately analytical” and it was way ahead of its time when it was developed decades ago: “It is the primordial quant strategy with logical inputs and objective outputs. Most importantly, it has proven a valuable guide to both professional and individual investors for more than three decades.” O’Neil’s work is surely the number one source of learning that an individual investor must read if he is serious about making money in the market.

Reference: O’Neil, W. J. (2009). How to Make Money in Stocks: A Winning System in Good Times and Bad (4ᵗʰ edition). New York, NY: McGraw-Hill Education.