William O'Neil and His Magical Formula ( PART 1)

Hi Investors,
Vanakkam


I read " How to make money in Stocks " by William O Neil last week. I am amazed that most of Mutual funds select stocks based on that method only. This book contradicts " The Intelligent Investor " in many ways. It is one of the best and must read books before investing. It suits very well in Indian Markets. There are many blogs and websites where an awesome summary of the book is available. I summarize it for the beginners. 

Preface
1. No of Bull Markets = No of Bear Markets. But, Bull Markets averages almost 100% increase and last for 2 years whereas Bear Markets averages only 30% decrease in price and last for 9 months.
2. Pessimists are 100% Failures
3. William O Neil has 35+ years of Experience as INVESTOR'S DAILY NEWSPAPER's author

Introduction
Learning from the greatest winners.
1. Everyone should own common stocks
2. Learn from successful investors
3. CANSLIM technique

a. C = Current Quarterly Earnings per Share
  • Quarterly EPS should have increased by a 25% to 500% compared to that of last year same quarter ( in Bull Markets, > 50% and in Bear Markets, > 20%). Larger the better.
  • EPS increase should be at least 10% increase than last quarter ( average 37%)
  • Increase in sales doesn't matter much. If sales has increased but profit has not, there could be a need for investigation
  • Don't Buy on Expectations
  • 2 Poor Quarters in the year indicates the stock will not perform better. Even 10% increase in EPS is considered poor in Bull Markets
  • Use log scale for convenience of analysing
  • Checkout the peers. At least one peer should have good EPS growth
  • Know about the dates of quarterly results well in advance. It helps in buying good stocks in time. Timing is equally important as EPS
b. A = Annual Earnings
  • Look for 5 year Annual Earnings ( AE ). It should grow linearly. If there is any dip in any year, the base trend should continue in the next year. the linear the better
  • Annual Growth average of 25 to 50% is better
  • Don't worry about PE ratio. It is clearly not the indicator of over valued stock. High PEs indicate BULL Market and Low PEs indicate BEAR Market.
  • EPS of last 2 quarters is more important than AE
c. N = New Products/ Managements/ Innovation
  • New products by the company or change in management may help in growth of the firm and stock price
  • 95% of stunning success is due to 'N'. 
Don't invest when the price is low. BUY @ previous HIGH*1.05 (OR HIGH*1.03) after correction period is over
Correction period is the period when the price tends to decrease after a HIGH. It takes about 3 weeks to 12 weeks. The price at the correction should not decrease beyond 15%. Don't BUY after HIGH*1.1 
Sudden Surge in Volume indicates upcoming PRICE change

d. S = Supply & Demand
  • Law of Supply and Demand is the basic law governing the Stock Market
  • If total volume of the company is tremendously HIGH, movement of price will be very difficult
  • Stocks with large holdings by Promoters is good BUYs
  • Many large, famous, old companies tend to decay slowly due to inefficient management or change in demand for their product. Even if they innovate, the profit of the innovations will not affect the mammoth size of their industry. So avoid them
  • LOW DEBT TO EQUITY RATIO is better
  • CONVERTIBLE BONDS should be less
e. L = Leader, Not Laggard
  • Buy a top 2 or 3 stock of its category
  • If you want to select one among 2 stocks of a category, Buy the stock which has good growth in price 
  • RELATIVE PRICE STRENGTH should be above 87 ( means the stock outperforms 87% of its peers in last 1 year in price growth)
  • Always ignore Laggard Stocks. In an IPL player auction, whom will you choose? Leader or Laggard??
SELL YOUR WORST STOCKS FIRST. 
If market is down by 10%, Buy a common stock only if it is down less than 10%. 

f. I = Institutional Sponsorship
  • Insurance companies, Mutual Funds, Charities, etc., buy stocks in huge quantity
  • They have a separate top level professionals to watch the stocks very precisely
  • Some of them are Aggressive ( BUY at HIGHs) and Some are Defensive ( BUY at LOWs)
  • They are very important for the companies as they buy in large quantities and sell only when they feel uncomfortable with the stock
  • Analysis of the top Mutual Fund Holdings may give idea about good stocks
g. M = Market Direction
  • Know whether the market is  Bull or Bear. 
  • SELL ALL YOUR HOLDINGS as you find the Bear Market is approaching.
  • SUDDEN HEAVY VOLUMES BUT NO PRICE CHANGE result in Market top
  • If the market is decreasing drastically, SELL your positions
  • Know at what stage of Bull or Bear it is
  • If laggard stocks suddenly attracts more investments than leader stocks( laggard stocks making 52 Week HIGHs ), the Bear market is approaching
  • If the most active stocks are ending in decrease in price or if the most active stocks are defensive stocks ( iron industry, tobacos, utilities, foods, etc.,) or laggard stocks, the Bear market is approaching
  • if the VOLUME IS HIGH when the price decreses, it indicates 'TOP REVERSAL'
  • if the VOLUME IS LOW when the price increases, it indicates Bear market
  • if the VOLUME IS LOW when the price decreases and/or VOLUME IS HIGH when the price increases, it indicates the beginning of new rally
  • INCREASE IN RBI RATES indicates Bear Market is approaching 
  • DECREASE IN RBI RATES indicates Bull Market is approaching
  • if ADVANCE-DECLINE LINE (a plot of the difference between no of nifty or sensex stocks increasing and decreasing throughout the day) decreases, it clearly indicates the approaching Bear Market
  • if A-D LINE increases, it clearly indicates the approaching Bull Market
  • Don't Predict the Market. Try to understand what it is doing
  • At the end of Bear Market, the RALLY ATTRACT MORE VOLUME BUT PRICE INCREASE WILL BE AROUND 1% ( in 10 days)
  • Don't Short in Bull Markets and Don't Buy in Bear Markets
  • You can expect more than 100% returns if you invest in correct stocks at the start of BULL MARKETS
  • Markets behave to the News as in the past. So analyse the past WAR TIMES, RECESSION PERIOD, ELECTION RESULTS, BUDGET SESSIONS, etc.,
      Bear/Bull Market Indicators

    1. 10 Day Moving Average of A-D line ( If it increases, BULL Market starts. If it decreases, BEAR Market starts)
    2. Upside-Downside Volume Ratio line ( If it increases suddenly in BEAR Market, the BULL Market starts)
    3. Short-Interest Ratio ( Ratio between total amount of short selling in a day and total trading volume of the day. At the end of BEAR Markets, Peaks arise and suddenly it turns negative indicating BULL Markets)
    4. Odd Lot Balance Index ( Ratio between Buying of Odd lots and Selling of Odd lots. If it increases, BULL Market. If it decreases, BEAR Market)
    5. Specialist Short Selling Index
    6. Mutual Funds Sales and Savings ( As more MFs are sold, BULL Market is approaching)
    7. Average price of Most active stocks ( If it increases, Bull Market is approaching. If it decreases, Bear Market is approaching)
    8. Defensive Stock Index ( As DSI increases, BEAR Market is approaching. As DSI decreases, BULL Market is approaching)
    9. Glamour Index ( It is opposite of DSI )
    10. New HIGH list stocks ( if more defensive stocks approach New HIGHs, Bear Market is approaching)
    11. RBI interest rates
We have seen CANSLIM in detail. Let us see when to SELL and BUY in next post.

If this post has helped you, please COMMENT AND SHARE.

 PSB

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