Another method to find a great company
The five market greats we have so far studied showed that value investing (buying at a bargain) works, and returns from growth investing are attractive but not without risks. In combination, they produce higher returns at less risk.
They also showed that the best way to win one’s game in the market is not only to look for a good company but to find a great company.
Both good and great company grow sales and profits over the years at rates greater than their industry average.
Drawing from Philip Fisher’s analogy, the difference is that a good company is one that can be described as “fortunate and able” while a great company is one that is “fortunate because it is able.”
To Fisher, a fortunate and able company “has a good product right from the start, solid management and it benefits from factors beyond the company’s control such as an unforeseen use of its product.” A fortunate-because-it-is-able company, on the other hand, “is one that might have a mediocre product to begin with, but the management team is so clever that they adapt the product to the marketplace and diversify into other areas that offer opportunity.”
Thus, a great company has a relative advantage over a good company because it has greater ability to generate long-term sales and profits.
These are the companies that Benjamin Graham identified to have a “margin of safety,” or what Peter Lynch calls “perfect companies,” “superior companies” to Philip Fisher, “good growth companies” to Gary Pilgrim and a “quality companies” to Warren Buffet.
Surprisingly, despite their impressive performances, none of these methods appeals to you. They seem to lack either the zing or practical substance that fits your psychological liking. Hopefully, the investing style of William O’Neil may just be what you are looking for.
William O’Neil is also a value investor. But like the rest of our study, he is always on the hunt for growth stocks. This makes him another quintessential “value-growth investor.”
O’Neil is best known as the founder of Investor’s Business Daily, a national business newspaper that competes with the The Wall Street Journal, which you may be more familiar with.
At 30, O’Neil purchased a seat on the New York Stock Exchange and founded his own investment research organization.
His investment style is presented in greater detail in his book (and subsequent editions along with other print supplements) “How to Make Money in Stocks.” He calls it the CAN SLIM approach.
This funny-sounding system is another way of picking a winning stock. It’s the acronym for the attributes of a great company.
According to O’Neil, only the presence of all the seven attributes he identified will be the basis of his decision to buy a stock. The presence of even a majority of these attributes will not be enough to make him buy the stock. He firmly believes that only the presence of all seven attributes will lead one to a winner.
The “C” stands for “current quarterly earnings per share.” It should be accelerating when compared to the same quarter of the prior year.
He warns about the play of percentages when appreciating them. Bigger percentage increases may look better than little ones. He said, a “900-percent earnings increase from one cent may look good. However, this is not as meaningful as a 100-percent earnings increase from a bigger base, like $1 from $0.50.”
“A” stands for “annual earnings per share.” It should be accelerating, too. O’Neil wants to see a continuing increase in the annual earnings of the company. Annual earnings in the last five years must be consistent and increasing. He says he would like to see a company’s earnings growth to be at least 25 percent a year, preferably 50 percent or 100 percent. He cites the following earnings progression for the last five years: “$0.70 per share five years ago, $1.15 in the following year, $1.85, $2.80 and $4.00 in the last three years.”
The “N” stands for “new something or other should be driving the stock to new highs.” Simply, this is akin to the economic moat of Warren Buffet. Something new is positively affecting the company’s future. This something new is at the same time pushing the company’s stock price to new highs, thus, making the current price look cheap.
The “S” is for “supply of stocks should be small and demand should be high.” O’Neil believes in the principle of supply and demand. “If two stocks are steaming upward at the same pace, the one with fewer shares outstanding will perform better,” he says.
The “L” is for “leaders in an industry should be your target.” As is said, there is nothing better than the best. But for O’Neil, this refers specifically to stocks with the best relative price strength. With the use of a mnemonic device, O’Neil says “a potential winning stock’s relative strength should be the same as a major pitcher’s fast ball.” According to accounts, he said “the average big league fast ball was clocked at 86 miles per hour and the outstanding pitcher’s throw was in the ’90s.” With this in mind, “look for stocks with relative price strengths of 90 or better.”
The “I” stands for “institutional sponsorship should be moderate.” O’Neil believes that institutional investors are the best source of demand in the stock market. But with them owning the same stock for the same reason can lead stock prices to go down drastically, too.
Reacting in the same way to adverse news, institutional investors can in turn dump the stock and send its price dropping drastically.
Letter “M” stands for the “market direction should be upward.” O’Neil believes, too, that “even if you get the first six factors of CAN SLIM right and choose a great portfolio of stocks but buy when the market as a whole is declining, 75 percent of your picks will sink with the market.”
It is, therefore, important that when you buy, the market should be generally on the uptrend. To get a feel of the market’s direction, he says you should “watch the market averages every day.”
Departing from what the six other legendary masters are saying, he strongly suggests that you “keep an eye on the daily price and volume charts of several different market averages.” As in their case in the United States, observe the chart and trend of the Dow, the S&P 500 and the NASDAQ composite.
Bottom line spin
Last week, the market again made a weekly gain. This time, it was bigger at 291 points or 4.75 percent, which now shows an upward pattern in the last two weeks.
Wall Street also had active trading though its major indices ended lower from their week’s high. But, just the same, the said indices seem to be edging higher like ours.
Not going through the ramification of the analysis, it looks like the market and Wall Street are on the verge of reaching equilibrium point. This week’s trading might just spell the market’s new trend.