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CANSLIM Overview
L is for
Leaders
"The first man gets the oyster; the
second, the shell."
- Andrew Carnegie, Steel Tycoon
The fifth thing to look for according to William O'Neil's CANSLIM
stock picking method is whether a stock is a leader or a laggard.
It's important to understand what O'Neil means here. He's not
talking about a leader in an industry. He means stocks that are
leaders in the stock market. He's talking about momentum.
In fact, the industry leaders - the giant well-established corporations - are
often "sentimental, draggy slowpokes" rather than the dynamic stock market
leaders we're looking for.
He cites, for example, the computer industry in 1979 and 1980. Industry giant
IBM languished, while snappy upstarts Wang Laboratories, Datapoint and others
soared. IBM may have been the industry leader. It was not the market
leader!
How do you find these market leaders? Relative Price Strength. This measure
compares a stock's price performance to the overall market as represented by the
S&P 500, the TSX Composite Index, or some other standard over a certain period
of time.
Observers of today' market will have noticed that there is a great deal of
difference in the action of the major indices. The NASDAQ and the TSX soared
while the Dow languished for the latter half of 1999. In the tech washout of
March and April of 2000, the Dow did better.
The S&P 500, on the other hand, is a very broad-based standard. The widest
standard is the Wilshire 5000 which encompasses almost every publicly traded US
company. It is the standard that the Hulbert Financial Digest uses in measuring
the performance of various stock market newsletters.
Whatever standard is used, the Relative Price Strength is calculated by
taking the stock's performance over a specified length of time (O'Neil suggests
six months or a year) and comparing it to the stocks in the market index. The
result is a number between 1 and 99 which is much like the centile figures given
on SAT tests. A number of 85 means that the stock you're looking at outperformed
85% of the stocks on the index.
O'Neil points out that "the 500 best-performing equities from 1953 to 1993
averaged a relative price strength of 87 just before
their major increase in price began". In other words, if you can find emerging
market leaders, you probably have a winning stock.
O'Neil recommends buying only those stocks with a relative price strength of
80 or more.
Beware of Sympathy Plays
O'Neil warns that success begets imitation. When a company becomes a market
leader through some new innovation, other companies are quick to join the
bandwagon. Witness the Internet explosion as a prime example. And some market
analysts and stock brokers will urge clients into a sympathy play. The leader
stock has advanced sharply. "The P/E is too high. It's too expensive. Try this
similar stock which isn't so pricey."
That, says O'Neil, is a big mistake. You want the leader, not the wannabe.
You want the oyster, not the shell! And such sympathy plays often turn out to be
duds.
Market Corrections
While stocks with a strong relative price strength outperform the market,
they also tend to underperform the market during a correction. O'Neil's studies
have shown that growth stocks will correct 1 1/2 to 2 1/2 times the market
average. So in the severe market correction of March and April 2000, when the
NASDAQ lost 35% of its value, many leading stocks lost considerably more than
that.
The stocks that lose the least - in other words, the stocks best surviving
the downturn - are the strongest and the best bet for a strong recovery.
On the other hand, you want to look out for stocks suffering a sudden and
unexpected decline. This could be a warning sign of trouble to come. This is
particularly so if it is the first major price break a stock encounters in its
bull run.
But if a stock actually gains during a market correction, that is a sign of
unusual strength. Such a stock could well become a big winner.
Finding Mo' Better Stocks
By mo' of course, we mean momentum! And there are a variety of resources to
find such stocks. One, of course, is O'Neil's newspaper, Investor's Business
Daily, which lists the RPS alongside each stock daily.
Another method is to subscribe to newsletters focusing on a momentum
approach.
Professor Stephen Foerster of the University of Western Ontario
Business School, his Ph.D. student John Schmitz and equity analyst
Anoop Prihar studied the stocks making up the TSE 100 and concluded
that a portfolio of the top ten stocks calculated on a weighted
average of performance over the previous four quarters and
rebalanced quarterly tended to outperform the TSX Composite average.
The study covered the years 1978 to 1992 and produced an average
annual return of 37.0% (after transaction costs) as against 13.4%
for the TSX. |
