One of the most popular elements of AAII membership is the Stock Screens area of AAII.com. Here, you can track the hypothetical performance of over 60 different stock investing strategies. Arguably one of the most-followed methodologies is that of William O’Neil. Back in the mid-1990s, the founder of Investor’s Business Daily published the book “How to Make Money in Stocks: A Winning System in Good Times or Bad” (now in its fourth edition: McGraw-Hill, 2009). In it, he outlined an approach based on the characteristics common to “every big winning stock each year since 1953.” This approach, which he called CAN SLIM, focuses on companies with a proven record of growth showing strong relative price strength and support from leading institutions.
In the July 1996 issue of the AAII Journal, former editor Maria Crawford Scott outlined O’Neil’s CAN SLIM approach based on the second edition of his book. Shortly thereafter, in the July/August 1996 issue of Computerized Investing, former editor and current AAII President John Bajkowski developed a stock screen based on the criteria O’Neil discussed in his book. Over the years, much has been written about the CAN SIM methodology in various AAII publications, so I won’t go into too much detail as to the system’s underlying characteristics. You can learn more about the screen and the criteria O’Neil developed by visiting the Stock Screens area of AAII.com (www.aaii.com/stock-screens).
The “Original” CAN SLIM
The CAN SLIM approach has been a strong performer on both an absolute and risk-adjusted basis over our backtesting period, which began at the end of 1997. Through the end of February of this year, the AAII CAN SLIM screen has averaged an annual return of 24.4%, ranking it third among all AAII screens. On a risk-adjusted basis, the screen has performed equally well, with an average annual return of 14.8%, which also ranks third among all AAII stock screens. The methodology’s strong performance has been enough to offset its relatively high risk: the CAN SLIM screen has a risk index of 1.89, which means the approach carries 89% more risk than the S&P 500 large-cap index. O’Neil is not afraid of risk, and he does not mind paying high premiums for the high-growth stocks that match his criteria.
Since we are talking about a screen that has performed well on both an absolute and risk-adjusted basis, it doesn’t seem that there would be a need to revise the criteria. Most of AAII’s stock screens are backtested over a period that begins at the end of 1997, with hypothetical portfolios invested in the stocks that pass a given methodology on an equal dollar basis and rebalanced at the end of each month, with buys and sells assumed to be made at the month-end price. For that reason, and the fact that our backtesting results do not take into account transaction costs such as commissions and bid-ask spreads, our reported results are not achievable by individual investors. However, since we follow the same procedure for all screens, the backtesting results provide an indication of how an approach would perform over time and over varying market conditions.
Looking at the backtesting results for the original CAN SLIM screen, some cracks began to appear. Between December 31, 1997, and February 28, 2013, the CAN SLIM screen has averaged seven passing companies a month. However, this only tells part of the story. While an investment strategy may look good on paper, it must be investable in the real world for it to be useful. If you look at a rolling 12-month average of the number of companies passing the CAN SLIM screen, the results are even more discouraging. Using this 12-month rolling average, the original CAN SLIM screen has had between 17 and only one company meeting the CAN SLIM criteria. Since mid-2007, no more than five companies on average have passed the screen and since the beginning of 2009, no more than two companies have passed on a rolling 12-month basis. Through the end of February, our backtesting period consists of 183 months. During this period, 16 months (9%) had no passing companies; 22 months (12%) had two passing companies; and 16 months (9%) had only three passing companies. That means that, for nearly a third of the months of our backtesting period, three or fewer companies passed the CAN SLIM screen. Having so few stocks pass the screen makes it difficult for an investor to build a diversified portfolio.
This is not to say that having few or no passing companies cannot sometimes be to your advantage. Take for example, the financial crisis of 2008—specifically, the bear market that began in October 2007 and ran through February of 2009. During this period, the S&P 500 lost 52.6% (not including dividends), while the typical AAII stock screen lost over 51%. Over this 17-month period, however, the CAN SLIM screen was out of the market (did not generate a single passing company) eight of those months. Part of the CAN SLIM criteria O’Neil outlined in the second edition of “How to Make Money in Stocks” calls for a company to increase its earnings in each of the last five fiscal years and generate average earnings per share growth of at least 25%. These criteria were enough to eliminate most companies during the brutal economic downturn that took place. Add to that the requirement that the stock price be within 10% of its 52-week high when the overall market is in freefall, and it’s no wonder few, if any, stocks were passing the screen. As a result, the hypothetical portfolio of the AAII CAN SLIM screen only lost 10.1% over that bear market period, with the next best screen losing 23.3%.
The Revised CAN SLIM
By and large, though, not having companies to invest in makes for a precarious position when pitching an investment strategy (or selling books). Perhaps for this reason, O’Neil released a third edition of “How to Make Money in Stocks” in 2002. This time, O’Neil extended his analysis of past market winners to 600 companies that performed strongly from 1953 to 2001 and revised, and in some cases relaxed, a number of CAN SLIM criteria. John Bajkowski highlighted the difference between the criteria outlined in the second and third editions of O’Neil’s book in the April 2003 issue of the AAII Journal, which is available here. Among the biggest changes O’Neil made was to require growing earnings over each of the last three years instead of each of the last five fiscal years and an average annual earnings per share growth rate of at least 25% over the last three years instead of over the last five years.
For the third edition of his book, O’Neil also moved away from his previous stance that stocks with a small or reasonable number of shares will, all else being equal, usually outperform older, large-cap stocks. In his research for the second edition of his book, O’Neil found that 95% of the winning stocks had fewer than 25 million shares outstanding. However, he never quantifies a maximum number of shares.
Based on the third edition of “How to Make Money in Stocks,” AAII developed a revised CAN SLIM screen. Relaxing the criteria has had two significant impacts. First, the overall performance of the revised CAN SLIM screen was lower than that of the original CAN SLIM approach, although it still outperformed the overall market by a strong margin. Since the beginning of 1998, the revised CAN SLIM screen has generated an average annual gain of 14.5%, versus 24.4% for the original CAN SLIM screen. The S&P 500 generated a 2.6% annual price gain over the same time period. On a risk-adjusted basis, the revised CAN SLIM screen has averaged an annual gain of 9.7% through the end of February (versus 14.8% for the original CAN SLIM screen). The second impact of the revised and relaxed criteria is a somewhat larger universe of stocks from which to choose. Between the end of December 1997 and the end of February 2013, the revised CAN SLIM screen averaged eight passing companies a month, an improvement of only one additional company over the original CAN SLIM screen. Looking at the rolling 12-month average, the revised CAN SLIM ranged from 19 to only one passing company. Over the entire backtesing period, the revised CAN SLIM screen was out of the market 14 months, only two less than the original CAN SLIM screen. This, again, helped investors avoid much of the carnage of the 2008 market meltdown. Over the last bear market period, the revised CAN SLIM screen lost 27.8%, faring better than all but four of the AAII stock screens.
Confronted with a powerhouse screen with very few passing companies and a revised screen with middling performance and not many more passing companies, we looked to see if there was a better way (or at least some better middle ground). Returning to the original CAN SLIM screen, one area for change immediately came to mind. As we mentioned earlier, O’Neil, in the second edition of “How to Make Money in Stocks” discussed investing in stocks with a limited number of outstanding shares. However, he never quantified a limit. AAII’s original CAN SLIM screen borrowed from research done by Marc Reinganum and published in the September 1989 issue of the AAII Journal, which found that stocks with big price movements had a relatively small number of shares outstanding, and set a cut-off at 20 million shares. Based on this research, the original CAN SLIM screened for a maximum of 20 million shares outstanding; this criterion was later changed to float when the data field was added to AAII’s Stock Investor Pro program, which is the platform used in developing all of our screens. Float is the total number of shares publicly owned and available for trading and is calculated by subtracting the number of shares owned by insiders from the total number of outstanding shares.
A “No Float” Strategy
Including a maximum shares outstanding/float criterion to the CAN SLIM screen was a bone of contention with some CAN SLIM devotees and was one not explicitly laid out in O’Neil’s book. Therefore, we decided to test the original CAN SLIM screen without the float requirement to see what impact it would have.
While the overall performance pales in comparison to the original CAN SLIM screen, our “no float” screen did improve upon the performance of the revised CAN SLIM methodology. Figure 1 shows a semi-log chart of $1,000 invested in all three CAN SLIM screens at the end of 1997. Assuming monthly rebalancing at month-end closing prices, and ignoring the impact of transactions costs, $1,000 invested at the end of 1997 in the “no float” CAN SLIM approach would have turned into $9,875 by the end of February of this year. This is nearly 16% better than the revised CAN SLIM screen, which would have turned $1,000 into $8,517. However, the original CAN SLIM screen is still the overwhelming winner, as it would have turned $1,000 into $30,765. By means of comparison, $1,000 invested in the S&P 500 at the end of 1997 would have grown to $1,565 (excluding dividends).
Figure 1 also shows the performance of the three CAN SIM screens for the last 10 years and for the year-to-date. On a risk-adjusted basis, the CAN SLIM No Float screen has averaged an annual gain of 12.5%, besting the revised CAN SLIM screen’s 9.7% risk-adjusted return. The No Float screen has a risk index of 1.39, meaning it has 39% more volatility than the S&P 500. Since 1998, the CAN SLIM No Float screen has had only two down years—2008 and 2011. The screen fared far worse than the other two CAN SLIM screens in 2008 because it was not out of the market like they were. As a result, during the last bear market the CAN SLIM No Float screen lost nearly 62% of its value, making it one of the worst-performing AAII screens over that period. During this same period, the S&P 500, excluding dividends, lost 52.6%.
However, during the bull market that started at the end of February 2009 and is ongoing, the CAN SLIM No Float screen has gained 135.9%, versus 111.8% for the original CAN SLIM screen and only 36.9% for the revised CAN SLIM approach. Meanwhile, the S&P 500 is up 106.5% over the same period.
Beyond improving on the performance of the revised CAN SLIM method, the CAN SLIM No Float screen also has a relatively greater number of passing companies. Since the end of 1997, the screen has averaged 16 passing stocks a month, which is at least double that of the other CAN SLIM screens. The maximum number of stocks passing in a single month was 53 and in only one month did no stocks pass (February 2009). Again looking at the rolling 12-month average, the No Float screen had between three and 28 stocks passing. In only 12 months out of the 183 in the backtesting period did three or less stocks pass.
Table 1 lists the 12 companies passing the CAN SLIM No Float screen as of February 28, 2013. The list is ranked in ascending order by the stock’s float. Only three of the 12 companies would have passed the original CAN SLIM screen, with its requirement for float to be under 20 million shares.
The three stock selection methodologies, at their heart, look for companies with strong earnings growth and price momentum. Making some slight, and not-so-slight, changes to the selection criteria can have a significant impact on the overall performance of the strategy. In the end, a screen that is truer to William O’Neil’s second edition of his book “How to Make Money in Stocks” outperforms the approach put forth in the third edition of his book, both on an absolute and risk-adjusted basis, while offering a deeper pool of candidates.