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Last week we introduced the CANSLIM investing strategy, pioneered by American investment guru, William O’Neil.  Although it truly is a valid investing strategy for growth stocks, it is controversial to some who see O’Neil’s organisational support in the publication Investors Business Daily and at Investors.com as blatant efforts at commercialising the system.  Somehow, investment gurus who do not profit from making money teaching their system to others are deemed more pure.

One of the claims made by CANSLIM proponents is that research shows conclusively that it works.  In truth, there is no rigorous academic research anywhere that proves any investing strategy works.

However, there is a not-for-profit group called the American Association of Individual Investors (AAII) that does do independent research comparing a wide variety of investing strategies whose criteria can be inputted into a stock screener.  

Here is what O’Neill’s website has to say about the most recent release of the AAII study of stock screening investing strategies.

February 2, 2010 – Los Angeles, CA – Investor’s Business Daily’s

CAN SLIM Investing System was the top-performing investing strategy from 1998 through 2009, according to an independent, real-time study by the American Association of Individual Investors (AAII). The study – which tracked over 50 leading investing methods through all the stock market’s ups and downs each month for the past 12 years, including the recent financial crisis – found the CAN SLIM system gained 2,763.3%, compared to a 14.9% gain for the S&P 500 over the same period; an average of 35.3% a year versus 3.3% a year for the S&P 500.

AAII conducted the first such study back in 2003 and the results were similar.  CAN-SLIM shares showed a 330.8% gain over the period that included what was up to that time, one of the worst bear markets in history.  

The folks at Investor.com clearly imply the study supports their view that CAN-SLIM is the most superior strategy out there.  Here is what the author of the study, AAII president John Bajkowski, had to say about the original findings:

As you look at the performance of the screens, do not blindly follow the strategies with the highest performance. Instead, try to gain an understanding of the forces impacting upon their performance and determine what kind of market environment could be expected in the future.

Obviously, AAII does not support the views expressed over at Investors.com.  The results cited are a good example of how to mislead with statistics.  The numbers quoted by Investors.com may be accurate, but they do not present the complete picture.  

Let’s take a look at three of the strategies included in the original 2003 study – CAN-SLIM, Graham’s Defensive Investor, which we examined in an earlier article on thebull.com, and one other – and see what is missing.  Here are the results for 1998 to 2002.

StrategyTotal Gains
2002  2001  2000  1999  1998  Cumulative
Monthly Holdings
% Holdover
O’Neil’s CAN-SLIM15.4   54.2   38.0   36.6   28.2               330.847.3
Graham’s Defensive Investor  4.0   61.5   12.0    3.6     9.6               113.480
Martin Zweig20.0   57.9   46.2   17.1   54.5               400.753.1

 

First, note that with the exception of 1999, the Martin Zweig investment strategy outperformed CAN-SLIM.  How can the O’Neill people make their claim?

The AAII segments the strategies into pure Value Strategies, Growth & Value Strategies, and pure Growth Strategies.   Martin Zweig was a prominent investment guru during the 1980’s and 1990’s in the United States.  His book, Winning on Wall Street, is a must-read for any serious investor.  His investment approach is considered a Growth and Value strategy, so the O’Neill people are technically accurate when they ignore his results.

While these AAII studies are interesting exercises regarding how to pick shares, what do they tell us about making money in share market investing?  Nothing.  Absolutely nothing.

Why not?  Note the last column in the table – % Monthly Holdover Holdings.  No one in any share market anywhere at any time has made a dime on paper.  These studies are a valuable educational endeavor, but they say nothing about when to sell the shares.  The monthly holdovers indicate the percentage of shares that continue to pass the screening criteria each month.  

To achieve the gains indicated in the table, an investor would have to rebalance his or her portfolio monthly, selling and buying shares based solely on the screening results.  Screeners are stock-picking tools, not necessarily sell tools.  One-time accounting charges could easily drive a share from the portfolio because it failed the screener one month and later return to the list.

CAN-SLIM sets out a solid set of selection criteria for picking growth shares.  As an investing strategy, however, its real value lay in its sell criteria.

Retail investors of all persuasions are obsessed with finding the best shares to buy.  Perhaps you have run across someone at work or at a neighborhood barbecue bragging about the 30% or 40% gain one of his shares made since purchased.  Until the share is sold, the gain is meaningless.  

CAN-SLIM has specific criteria for exiting a stock both in the event of a loss, and equally important, in the event of a gain.  The original criterion for exiting or selling at a loss was a 7-8% drop in share price.  Some investors will not even consider exploring the share picking criteria of CAN-SLIM because they find that loss provision to be too restrictive.  However, in the long run, it preserves capital that allows you to reinvest in other shares.

Losses are painful so some investors hang on to a share in the hopes it will rise from the ashes someday.  But all the while, they are agonising over whether they should sell or not.  Not so with exiting with a profit.  When shares we own are on the rise, many of us prefer to sit back and watch them sprint forward.  CAN-SLIM has a criterion for this eventuality as well, although not as rigid.  

The original edition advised retail investors to begin considering exiting a share once the gains reached the 20% to 30% range.  While some see that as overly restrictive, it guarantees you are locking in some profit at one end, while your exit at a loss criterion minimises losses at the other.  

Regardless of how you play the share market investing game, if you do not have some idea of when to exit a losing position and when to take some money and run, you are not following any strategy at all.