CANSLIM Strategy – Backtesting And Performance With Innovator IBD 50 ETF

The founder of Investor’s Business Daily (IBD), William O’Neill developed the CANSLIM method to help him pick the best stocks. In his best-selling book How To Make Money In Stocks, O’Neill described his method in detail. CANSLIM is a method about how to make money in stocks, but does it work? We looked at empirical results and conclude the following:

Yes, the CANSLIM strategy method works and has beaten the S&P 500 since 2003, according to backtests. But the outperformance comes at a cost in terms of higher volatility and larger drawdowns.

Because the CANSLIM method has big exposure to the small-cap segment, we might argue the outperformance is due to the fact that small-caps have beaten large-caps over the long run.

In this article, we look more into the CANSLIM method. We also provide you with a backtest of the CANSLIM method that is based on its ETF.

Let’s get started:

What is the CANSLIM method?

CANSLIM is an acronym for seven variables developed by William O’Neill. The seven variables are used to define “good stocks” that O’Neill argued were common factors for all the best-performing stocks from 1953 until 1993, a period of 40 years.

In his book How To Make Money In Stocks William O’Neill wrote extensively about the CANSLIM method. Every part of the CANSLIM method is covered by its own chapter in addition to many other chapters. We bought the book in 1998 and found the book both insightful and interesting, despite its lack of a complete quantified approach.

O’Neill argued CANSLIM is a simple and easy-to-use system. We tend to disagree. Because of the seven factors in his checklist, we believe this is a pretty difficult system to implement. To understand why we need to look deeper into what the CANSLIM method is:

• C is for current quarterly earnings per share. According to O’Neill, 75% of the 500 best-performing stocks from 1953 showed big positive jumps in quarterly earnings per share before they went on to appreciate in value. O’Neill recommends at least a 25% jump in earnings.
• A is for annual earnings increases. This is what O’Neill wrote about the A: “The annual compounded growth rate (CAGR) of earnings in the superior firms you hand-pick for purchasing stock should be from 25% to 50%, or even 100% or more, per year over the last 4 or 5 years”.
• N stands for new products, new management, new highs. This is what O’Neill writes in his book: “In our study of greatest stock market winners from 1953 through 1993, we discovered more than 95% of these stunning successes in American industry either had a major new product or service, new management, or an important change for the better in the conditions of their particular industry.”
• S is for supply and demand. We quote from the book: “The law of supply and demand is more important than all the analyst opinions on Wall Street….If you are choosing between two stocks to buy, one with 10 million shares outstanding and the other with 60 million, the smaller one will usually be the rip-roaring performer if other factors are equal.”
• L stands for leader or laggard. O’Neil’s research concluded like this: “The 500 best-performing listed equities for each year from 1953 through 1993 averaged a relative price strength rating of 87 just before their major increase in price actually began. So the determined winner’s rule is: avoid laggard stocks and avoid sympathy movements. Look for genuine leaders!….Sell your worst-performing stocks first and keep your best-acting investments a little longer.”
• I stands for Institutional sponsorship. “A stock certainly does not need a large number of institutional owners, but it should have at least a few such sponsors. Three to ten might be a minimum or a reasonable number of mutual fund sponsors, although some stocks might have a good deal more.”
  
• M stands for Market Direction: “You can be right about every one of the factors in the first six chapters, however, if you are wrong about the direction of the broad general market, three out of four of your stocks will slump with the market averages and you will lose money…The best way to determine the market’s direction is to follow and understand every day what the general market averages are doing.”

As you can see, some of the criteria are quantifiable while others are more difficult to quantify.

The good thing is that you don’t need to do anything as long as you subscribe to Investor’s Business Daily. Every week they provide a list of the 50 best picks that fit the seven CANSLIM criteria. The list is called IBD 50:

What is the IBD 50?

The IBD 50 is a reference to the best 50 stocks that fit the CANSLIM method. IBD is an abbreviation for Investors’ Business Daily. The IBD 50 is computer-generated and ranked mathematically based on the seven CANSLIM criteria.

The proprietary list appears twice a week in Investor’s Business Daily print edition. In the digital version, you get an updated version every Friday (investors.com). Only paid subscribers get the whole list, and as a non-subscriber, you get to see only a sample of ten stocks.

The portfolio turnover is quite high, although there are no updates from IBD on the exact turnover.

Let’s go on a look at the performance of the CANSLIM method:

How has the CANSLIM method performed? Backtest

Originally, the CANSLIM method depended a great deal on discretionary judgment. Because of this, we have yet to see a backtest of a completely computer-generated backtest prior to 2003.

We are not subscribing to IBD but we managed to find an old performance report which looks like this:

It’s a solid outperformance: 18% CAGR against 9% for the S&P 500. Such an outperformance is often not sustainable (see more of this below).

The graph shows that a weak market makes the IBD 50 go down a lot. The index tends to perform quite well in bullish markets but drops significantly in bearish markets. Given the bias toward the small-cap segment, this shouldn’t be surprising.

Thus, you must be willing to accept huge drawdowns for this strategy to work to avoid ruining behavioral mistakes.

To get an updated version of how the strategy has performed after 2015, we need to look at the Innovator IBD 50 ETF:

CANSLIM ETF: Innovator IBD 50 ETF (backtest)

What is the best method to get exposure to IBD 50 and the CANSLIM methodology?

You can, of course, subscribe to IBD’s services and do the portfolio allocations manually yourself.

Trading Rules

THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES CLICK HERE TO SEE ALL 350 ARTICLES WITH TRADING RULES

FAQ CANSLIM

Let’s end the article with a few frequently asked questions about the CANSLIM method:

How do you screen a CANSLIM stock?

The CANSLIM method provides criteria for screening stocks. These include factors like current quarterly earnings per share, annual earnings increases, new products, new management, new highs, supply and demand, leader or laggard status, institutional sponsorship, and market direction.

How does the CANSLIM method work?

The CANSLIM method is primarily meant for long-term investing, not trading. The CANSLIM method works by focusing on stocks with strong fundamentals, such as positive earnings, good growth, and institutional sponsorship. It also considers stocks that are in an uptrend.

How can I use the CANSLIM Method to select stocks?

To use the CANSLIM method to select stocks, look for stocks with strong fundamentals, positive earnings, good growth, institutional sponsorship, and those in an uptrend. Risks associated with the CANSLIM method include market volatility, potential loss of capital, and the possibility of investing in companies that may not perform as expected. Recent performance suggests underperformance compared to the S&P 500.

Does the CANSLIM method work?

Backtests suggest that the CANSLIM method worked really well in the past, but it has not performed so well in the recent years.

How do you screen a CANSLIM stock?

The CANSLIM contains all the letters you need to scan for such a stock. You find the meaning behind every letter further up in the article.

Is it easy to backtest the CANSLIM method?

Unfortunately, it’s not. Because you need both fundamental and technical data, it’s quite demanding to backtest the strategy. It’s also diffucult to set the proper technical trading rules and settings.

What’s the best resource to leanr about the CANSLIM method?

That is undoubtedly William O’Neil’s book called How To Make Money In Stocks.

Is the CANSLIM method for long or short term investing?

We would argue it’s mostly meanmt for long-term investing – not trading.

How does the CANSLIM method work?

The CANSLIM method works by focusing on stocks with strong fundamentals, such as positive earnings, good growth, and institutional sponsorship. Investors should also look for stocks that are in an uptrend, as this indicates that the stock is likely to continue to appreciate in value.

How can I use the CANSLIM Method to select stocks?

To use the CANSLIM method to select stocks, you should look for stocks with strong fundamentals, such as positive earnings, good growth, and institutional sponsorship. You should also look for stocks that are in an uptrend, as this indicates that the stock is likely to continue to appreciate in value.

What are the risks associated with the CANSLIM Method?

As with any investment strategy, there are risks associated with the CANSLIM method. These risks include market volatility, the potential for loss of capital, and the possibility of investing in companies that may not perform as expected. Therefore, it is important to research any stock thoroughly before investing. As mentioned, the method has not worked well in recent years and thus underperforming S&P 500 heavily.

CANSLIM – Does It Work? Conclusion

Backtests reveal that the CANSLIM strategy method has proven to beat the S&P 500 since 2003 but it comes at a cost: high volatility and large drawdowns. Because CANSLIM gravitates toward the small-cap segment, the outperformance might as well come as a result of the long-term small-cap bias: Over many decades small-caps have beaten large-caps, most likely because they have a longer runway.