CANSLIM – Does It Work? (Backtest And Innovator IBD 50 ETF)

Last Updated on June 19, 2022 by Quantified Trading

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 called How To Make Money In Stocks O’Neill went on to describe his method in detail. CANSLIM is a method on how to make money in stocks, but does it work? We looked at empirical results and conclude the following:

Yes, the CANSLIM 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.

Let’s look more into the CANSLIM method:

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 direction of the market 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?

IBD is an abbreviation for Investor’s Business Daily, and 50 is a reference to the best 50 stocks that fit the CANSLIM method. It’s 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 turnover of the portfolio 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.

An easier solution is to buy the ETF that tracks the IBD 50. The ticker code is FFTY and the fund is managed by the Innovator Funds, and called Innovator IBD 50 ETF. The fund simply takes the same positions in the 50 stocks published in Investor’s Business Daily. Portfolio changes are done weekly and the expense ratio is pretty high at 0.93% annually. The ETF was incepted in April 2015 and has thus a few years’ track record.

How has Innovator IBD 50 ETF performed? Since its inception performance has not been so good:

Remember that the IBD 50 outperformed massively from 2003 until 2015, but as you can see, performance has been very poor after Covid-19.

As mentioned above, the volatility of the IBD 50 is higher than the S&P 500 and you can expect higher drawdowns, as can be seen from the second half of 2021. However, adjusted for the expense ratio, the Innovator IBD 50 ETF has managed to track the IBD 50 index pretty well so the lack of performance is not due to the management of the ETF.

CANSLIM – Does It Work? Conclusion

Backtests reveal that the CANSLIM 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 simply have a longer runway.

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