RE: Summary of O'Neil's "How to Make Money in Stocks"
Thread,
The following is a summary of the major points William J O'Neil makes in his book "How to Make Money in Stocks - A Winning System in Good Times or Bad". He calls this strategy the C-A-N S-L-I-M method. As Herman said in his post, this method provides a good starting point for evaluating the fundamentals of a company. These ideas are not my original thoughts, but those of the books author. The major points of the method are as follows:
C = CURRENT EARNINGS PER SHARE:
Rule: Current earnings per share must be up at least 18% or 20% over the same quarter last year. EPS > 80.
The percentage increase in earnings per share is the single most important element in stock selection. The greater percentage increase the better. Make sure you are not fooled by comparing current earnings to nearly nonexistent earnings for the same quarter last year. Ignore non-recurring earnings, they are not representative of the ongoing profitability of corporate operations. Check the industry group for the stock. You should be able to find at least one other company in the industry group showing good current earnings.
A = ANNUAL EARNINGS PER SHARE:
Rule: Each year's annual earnings per share for the last five years should show an increase over the prior year's earnings. EPS > 80.
The annual compounded earnings growth rates in the superior companies you consider for purchasing stocks should be at least 25% per year over the last 4 or 5 years. The earnings estimates for next year should also be up a healthy percentage. Remember estimates are opinions.
A standout stock needs a sound growth record not only during recent years, but also needs strong current earnings record in the last few quarters. It is the unique combination of these two critical factors, rather than one or the other being outstanding, that creates a superb stock. Investors Business Daily (IBD) provides a relative earnings ranking (EPS) for all common stocks listed on NYSE, AMEX, and NASDAQ. Each stock is ranked on a scale from 1 to 99. An 80 earnings per share rank means a company's current and five-year historical earnings record outclassed 80% of all other companies.
Analysis of each market cycles winning stocks show that P/E ratios have very little to do with whether a stock should be bought or not. During the 33 years from 1953 through 1985 the average P/E for the best performing stocks at their early emerging stage was 20 (the Dow Jones Industrial's P/E at the same time averaged 15). While advancing, these stocks expanded their P/E's to about 45. These figures strongly imply that if you were not willing to pay an average of 20 to 30 times earnings for growth stocks in the 40 years through 1993, you automatically eliminated most of the best investments available. Don't buy a stock solely because the P/E looks cheap. There are usually good reasons why it is cheap.
N = NEW:
Rule: Buy companies with new products, new management, or significant new changes in their industry conditions. And most important, buy stocks as they initially make new highs in price. Companies whose stocks are emerging from price consolidation patterns and are close to, or actually touching, new highs in price are usually your best candidates. (Forget cheap stocks; they are usually cheap for a very good reason.)
It takes something new to produce a startling advance in the price of a stock. Search for corporations that have a key new product or service, new management, or changes in conditions in their industry. I think a lot of the issues Dave listed fit under this category.
S = SUPPLY AND DEMAND:
Rule: There should be a small or reasonable number of shares outstanding (< 25 million shares), not large capitalization, older companies. And look for volume increases when a stock begins to move up.
The law of supply and demand is more important than all of the analyst opinions on Wall Street. More than 95% of the companies had fewer than 25 million shares in their capitalization when they had their greatest period of earnings improvement and stock market performance. The physical laws of nature state that is easier to get a small object moving than a large one. Large capitalization stocks as a rule produce dreadful price appreciation simply because the companies are to big and sluggish. The average capitalization of top-performing listed stocks from 1970 through 1982 was 11.8 million shares. The medium stock exhibited 4.6 million shares outstanding before advancing rapidly in price.
Look for companies who 1) have a large percentage of ownership by top management, 2) are buying their own stock in the open market, and 3) have low Corporate debt to equity ratios.
L = LEADERS:
Rule: Buy market leaders, avoid laggards. RS > 80
Investors Business Daily provides a daily rating of market leadership. It is called Relative Price Strength (RS). Each stock in the NYSE, AMEX, and NASDAQ are rated from 1 to 99. Relative price strength normally compares a stock's price performance to the price action of a stock to all other stocks. A relative strength of 70 means a stock outperformed 70% of the stocks in the comparison group during the given period.
I = INSTITUTIONAL SPONSORSHIP:
Rule: Buy stocks with at least a few institutional sponsors with better than average recent performance records.
It is not always as crucial to know how many institutions own a stock as it is to know which of the better ones own or have purchased a particular stock in the last quarter. The only important thing about the number of institutional owners is to note the recent quarterly trend. Is the number of sponsors increasing or decreasing?
M = THE GENERAL MARKET:
Rule: It will determine whether you win or lose, so learn to interpret the daily general market indexes (price and volume changes) and action of the individual market leaders to determine the overall market's current direction.
Recognizing when the market has hit a top or bottomed out is 50% of the whole complicated ball game. It is the key investing skill that all-too-many professional and amateur investors seem to lack. Along with following the daily price and volume changes in the DOW and S&P 500 indices, the indices Herman recommended look to be vary helpful.
Mr. O'Neil has lots of good ideas,
Blaine |
