Should you bet on growth stocks or value stocks? Should you buy stocks only after they fall, because they’re available at a cheaper price? Or should you buy even rallying stocks with the hope and expectation that they’ll rise more? These are common questions that haunt every investor in the market day in and day out.
After studying hundreds of charts dating back to the 1880s and analyzing stock prices to figure out patterns that increase the odds of success, he concluded that it pays to always buy strong, upward-trending stocks.
O’Neil is one of the greatest stock traders of his generation, achieving 5,000% returns on his portfolio over a 25-year period.
He was born March 25, 1933, in Oklahoma City and graduated from Woodrow Wilson High School in Dallas in 1951. He studied business at Southern Methodist University and received his bachelor’s degree in 1955. He later served in the US Air Force.
O’Neil started his career as a stockbroker at Hayden, Stone & Co. in 1958, where he developed an investment strategy that made use of computers.
While at Harvard Business School, O’Neil invented the CANSLIM strategy, a bullish formula for determining which stocks are likely to grow. He also became a top-performing broker at Hayden Stone.
In 1963, he founded William O’Neil + Co. and developed the first computerised daily securities database and sold its research to institutional investors, tracking more than 70,000 companies worldwide.
O’Neil also founded the influential investment publication Investor’s Business Daily, which News Corp acquired by in 2021.
O’Neil’s CANSLIM strategy combines fundamental analysis, technical analysis and risk management. It delivered some 2,763% returns over 12 years.
O’Neil’s use of computers to collate and analyze stocks data played a key role in his investing success throughout the 1960s and 1970s.
CANSLIM strategy is an acronym that stands for:
C: Current quarterly earnings per share (up at least 25% vs. year-ago quarter).
O’Neil says when investors look for companies to invest in, they should compare the current quarterly earnings per share figure with that of the same quarter in the previous financial year. The higher the percentage of growth, the better the company is fundamentally.
A: Annual earnings increase at a compound rate of no less than 25%.
O’Neil says the revenue that a business generates should preferably grow year over year. Hence, one should look for companies with an annual earnings growth rate of 20-25% over the past 3-5 years.
N: New products, new management and new highs.
O’Neil says ones should preferably invest in companies that are on a continuous path towards innovation and development. Without the release of any new product, service, or event, a company’s stock price is likely to stay stagnant and not appreciate in price. On the other hand, if a company is constantly developing new products or is in the news for positive reasons, the stock price is likely to witness a huge boost.
S: Supply and demand
O’Neil says a company’s stock should ideally be scarce in supply, backed by strong demand. This ensures that the stock enters the excessive demand territory, which can rapidly push up its price.
L: Leaders and laggards.
Investors should keep track of stocks that outperform and get rid of the laggards. One should always look towards investing in a leading company in a leading industry, he says.
I: Institutional ownership
O’Neil is of the view that an investor should always look at the institutional shareholding pattern of a company before investing in it. A company that’s favourable for investing should have a higher level of institutional ownership.
M: Market direction
According to O’Neil, three out of four stocks follow the market trend, and when the intermediate trend is bearish, investors shouldn’t invest. He says an investor should thoroughly analyze the market movement to confirm a strong uptrend before deciding to invest in a company.
In his book, O’Neil lists out 20 common mistakes that an investor should avoid in order to ensure better returns. Here’s a look at them:-
- Stubbornly holding on to losses
O’Neil says most investors can get out of a trade cheaply, but they let emotions get the better of them.
“You don’t want to take a loss. So you wait and you hope, until your loss gets so large that it costs you dearly. This is by far one of the greatest mistakes nearly all investors make. They don’t understand that all common stocks can be highly speculative and can involve large risks. Without exception, you should cut every single loss short,” he says.
O’Neil says an investor should cut all their losses immediately when a stock falls 7-8% below the purchase price. Following this simple rule, one can survive for another day to invest and capitalise on the many excellent opportunities in the future.
- Buying on the way down in price
A declining stock seems like a real bargain because it’s cheaper than it was a few months earlier, but this strategy often leads to miserable results. “In late 1999, a young woman I know bought Xerox when it dropped abruptly to a new low at $34 and seemed really cheap. A year later, it traded at $6. Why try to catch a falling dagger?” he asks.
- Averaging down in price
O’Neil says if an investor buys a stock at $40, then buys more at $30 and average out the cost at $35, then he is following up their losers and throwing good money after bad trades. This amateur strategy can produce serious losses and weigh down the portfolio with a few big losers.
- Being afraid to buy stocks at new highs
Investors generally think that a stock making a new high is too high. But O’Neil says personal feelings and opinions are far less accurate than the market itself. “The best time to buy a stock in a bull market is when it initially emerges from a price consolidation or sound ‘basing’ area of at least seven or eight weeks. Get over wanting to buy something cheap on the way down,” he says.
- Having a poor selection criteria
O’Neil says investors need to understand which fundamental factors are crucial and which are simply not that important. Many investors make the mistake of buying poor quality stocks that are not acting particularly well; have questionable earnings, sales growth and return on equity; and are not the true market leaders.
- Not having rules to tell when a correction starts
O’Neil says it’s critical that investors are able to recognise market tops and major market turnarounds coming off the bottom, if they want to avoid significant losses. “You must know when the storm is over and the market tells you to buy back in and raise your market commitments. You can’t go by your opinions or feelings. You must have specific rules and follow them religiously,” he said.
- Not having a disciplined trading approach
The best of trading rules are of no help if one fails to develop the discipline to make decisions and act according to proven rules and game plan.
- Not knowing when to sell a stock
Investors should make some rules or plan for selling stocks, otherwise it can cost them badly and can hamper their journey to success.
- Importance of buying quality companies
Investors should buy high quality companies with good institutional sponsorship and should learn how to use charts to improve selection and timing.
- Buying more of low-priced stocks
O’Neil says most investors think it’s smarter to buy round lots of 100 or 1,000 low-priced shares, which make them feel like they’re getting a lot more for their money. “They’d be better off buying 30 or 50 shares of higher-priced, better quality, better-performing companies. Think in terms of dollars when you invest, not the number of shares you can buy. Buy the best merchandise available, not the cheapest,” he said.
- Buying on tips, rumours and news
Most investors fall into the trap of risking their hard-earned money on the basis of what someone else says. “Most rumours and tips you hear simply aren’t true. Even if they are true, in many cases the stock concerned will ironically go down, not up as you assume,” he says.
- Betting on dividends or low P/E ratios
Dividends and P/E ratios aren’t as important as growth in earnings per share. In many cases, the more a company pays in dividends, the weaker it may be. “Better-performing companies typically will not pay dividends. Instead, they reinvest their capital in research and development (R&D) or other corporate improvements. Also, keep in mind that you can lose the amount of a dividend in one or two days’ fluctuation in the stock price. As for P/E ratios, a low P/E is probably low because the company’s past record is inferior. Most stocks sell for what they’re worth at any particular time,” he says.
- Wanting to make a quick buck
Wanting too much, too fast without doing the necessary research or acquiring the essential skills and discipline can lead investors downfall. “Chances are, you’ll jump into a stock too fast and then be too slow to cut your losses when you are wrong,” he says.
- Buying old names you’re familiar with
Many of the best investments will be newer names that investors won’t know. With a little research, investors can discover and profit from these new stocks before they become household names.
- Not being able to follow good advice
Friends, relatives, certain stockbrokers and advisory services can all be sources of bad advice as only a small minority are successful enough themselves to merit investors’ consideration.
- Cashing in small, easy-to-take profits
Investors should cut their losses short and give their profits more time.
- Worrying way too much about taxes
Excessive worries about taxes usually lead to unsound investment decisions in the hope of achieving a tax shelter. “You can also fritter away a good profit by holding on too long in an attempt to get a long term capital gain. Some investors convince themselves they can’t sell because of taxes, but that’s ego trumping judgment,” he says.
- Speculating heavily on options or futures
Some investors focus mainly on shorter-term, lower-priced options that involve greater volatility and risk. The limited time period works against holders of short-term options.
- Not being able to make quick decisions
Many investors don’t know whether they should buy, sell or hold a stock, and the uncertainty shows that they have no guidelines. “Most people don’t follow a proven plan, a set of strict principles or buy and sell rules, to correctly guide them,” he says.
- Not looking at stocks objectively
Many investors pick their favourites and hope for the best. Instead of relying on hope and their own opinions, successful investors pay attention to the market, which is usually right. “How many of these describe your own past investment beliefs and practices? Poor principles and methods yield poor results; sound principles and methods yield sound results,” he said.
O’Neil feels investors shouldn’t feel discouraged when they make mistakes while investing and should just remember to work on their weaknesses until they become their strong points.
“It takes time and a little effort to get it right, but in the end, it’s worth every minute you spend on it. You can learn to invest with knowledge and confidence to protect your money and at the same time find and properly handle highly successful companies,” he says.
(Disclaimer: This article is based on William O’Neil’s book “How to Make Money in Stocks: A Winning System in Good Times and Bad.”)