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William O'Neil: Fundamental and Technical Analyses Combined

- By Robert Abbott

Do an online search for great investors or great investing books, and you're sure to see William J. O'Neil's name show up in the top-10 lists. He has an excellent investing record based on a system of his own devising called CAN SLIM and founded the advisory service Investor's Business Daily. After starting in the investment industry in 1958, he started his own brokerage business in 1963 and Investor's Business Daily in 1984.

His book, "How to Make Money in Stocks: A Winning System in Good Times and Bad," was first published in 1988 and has since racked up four editions, the most recent of which was published in 2009 (the edition that is used here).

O'Neil's investing style is more eclectic than those of most proponents of value investing or growth investing. He has a foot in both camps, he embraces technical as well as fundamental analysis, but is mostly known as a growth investor.

In his Introduction, O'Neil wrote that investors should learn, and benefit, from the super winners of the past 100 years. To start, there are several recommendations for avoiding losses:

  • Buy stocks that are going up in price, not down, and if you buy more you should do so only after the stock is above your original purchase price.

  • Buy stocks that are close to their high for the year, not when they've dropped and appear cheap. Invest in higher-priced, better-quality stocks, not in the lowest-price stocks (echoes of Charlie Munger (Trades, Portfolio)).

  • Among the fundamentals, give less attention to book value, dividends and the price-earnings ratio, and more attention to strong earnings and sales growth, price-volume metrics and whether the company is the profit leader with superior new products.

  • Do not subscribe to too many market newsletters or advisory services.

  • Get familiar with daily, weekly and monthly price and volume charts.

  • Apply "time-tested sell rules" to determine when to get out of a position, as well as buy rules to guide you back into the market.

In winding up this section, he wrote, "The stock market is human nature and crowd psychology on daily display, plus the age-old law of supply and demand at work. Because these two factors remain the same over time, it is remarkable but true that chart patterns are just the same today as they were 50 years ago or 100 years ago." In other words, expect the past to repeat itself.

And in what he called a "Secret Tip," he advised that the first step in becoming a successful investor is to examine great successes from the past, and the price and earnings patterns they displayed immediately before "spectacular" price increases.

Included in those patterns -- both fundamental and technical -- are quarterly and annual earnings histories, how much trading value was involved, the relative strength of their share prices and the number of common shares outstanding. In addition, O'Neil reported that many of the biggest winners had significant new management, new products or ties to strong industry moves.

O'Neil also wanted investors to understand and use charts, "Charts plus earnings will help you tell the best stocks and general markets from the weaker, riskier stocks and markets that you must avoid altogether."

Backing up these assertions was his own research; at the core of it are charts of the most successful stocks in each year for the previous 125 years (this book was published in 2009). His examples (not necessarily set at one year) include:

  • Texas Instrument (TXN): Between January 1958 and May 1960, it jumped 10-fold, from $25 to $250.

  • Xerox (XRX): It popped from $160 in March 1963 to $1,340 in June 1966.

  • Cisco Systems (CSCO): In October 1990 it was worth 10 cents, and by March 2000 it had shot up to $82.00 (split adjusted).

All of O'Neil's research and thinking was brought together in what he called CAN SLIM. Each letter in CAN SLIM stands for one of the seven characteristics of the winning stocks he studied:

C: Current quarterly earnings and sales (the higher, the better).

A: Annual earnings increases (watch for significant growth).

N: New products, new management, new highs (buy at the right time).

S: Supply and demand (shares outstanding plus big volume demand).

L: Leader or laggard (which is your stock?).

I: Institutional sponsorship (follow the leaders).

M: Market direction (how you can learn to determine it).

O'Neil said of his formula, "It's based 100% on realistic historical studies of how the stock market has actually worked rather than on our personal opinion or anyone else's, including Wall Street's ... or academic theorists. Furthermore, human nature at work in the market simply doesn't change."

How well has the formula worked? No doubt different investors have generated different results, but a comparison between CANGX (a mutual fund based on CAN SLIM) and VMGRX (Vanguard Mid-Cap Growth Fund) -- Morningstar categorizes them both as mid-cap funds -- is not flattering to CAN SLIM, subject to a couple of caveats discussed below:

CANGX trailing returns
CANGX trailing returns
VMGRX trailing returns
VMGRX trailing returns

As these Morningstar tables show, the Vanguard fund has a 10-year record that easily outdistances the fund based on CAN SLIM.

Now, the caveats:

  • The fund is not run by O'Neil, but by what appears to be an independent fund manager, NorthCoast Asset Management.

  • According to the performance chart on the fund's website, CANGX had a 10-year annualized return of 7.82%, compared to 13.12% for the S&P 500.

  • Morningstar reports CANGX has an above-average expense ratio of 1.43%, plus a turnover rate of 218%, both of which will have pulled down returns.

So CAN SLIM, as executed by CANGX, has been disappointing when compared with a peer and with the S&P 500; we acknowledge, though, that CANGX may not be the best representation of the formula.

In any case, William J. O'Neil's ideas have substance and are worth the time of value investors, especially those who seek to broaden their horizons.

(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

This article first appeared on GuruFocus.