Stock-market wizard William O'Neil famously turned $5,000 into $200,000 in just a few years. Here's the 7-part model he uses to sniff out winning stocks.

  • William O'Neil, the legendary trader and author of "How to Make Money in Stocks," described his "CANSLIM" trading methodology in Jack Schwager's "Market Wizards" series.
  • After he grew frustrated with the advice and techniques being pitched through investment letters, O'Neil set out to develop his own strategy for spotting the market's next big winners.
  • O'Neil famously turned $5,000 into $200,000 from just a handful of trades, according to Schwager's text. 
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"I went through the same process that most people do. I subscribed to a few investment letters and most of them didn't do too well."

That's what William O'Neil, the legendary trader and author of "How to Make Money in Stocks," told Jack Schwager in a 1989 interview for his classic "Market Wizards" series.

Out of frustration, O'Neil took the matter into his own hands. He knew a better way to trade was out there — all he had to do was uncover it. After all, he was seeing an array of fund managers crush the competition.

"Back in 1959, I did a study of the people that were doing very well in the market," he said. "At that time, the Dreyfus fund was a very small fund, managing only about $15 million. Jack Dreyfus, who managed the fund, was doubling the results of all his competitors."

O'Neil scoured Dreyfus' quarterly reports, searching tirelessly for any commonalities he could apply to his own methodology. After mapping out more than 100 of Dreyfus' stock purchase points, O'Neil hit pay dirt.

"There were over 100 of these securities and when I laid them out on a table, I made my first real discovery: Not some, not most, but every single stock had been bought when it went to a new high price," he said.

That unearthing opened the flood gates. O'Neil knew there were more secrets waiting to be uncovered. 

The search continued. 

O'Neil shifted his focus to the market's biggest winners, trying to connect the dots between the characteristics of certain stocks and their superior performance. Eventually, his research culminated in a simple seven-part model: CANSLIM.

Allow O'Neil to explain:

"Each letter of this name represents one of the seven chief characteristics of the all-time great winning stocks during their early developing stages, just before they made huge advances," he said.

O'Neil's discovery translated to massive profits.

"During 1962-63, by pyramiding the profits in three exceptional back-to-back trades — short Korvette, long Chrysler, and long Syntex — he managed to parlay an initial $5,000 investment into $200,000," Schwager said.

Let's take a closer look at O'Neil's famed CANSLIM principles. All quotes below are from O'Neil.

C: 'Current earnings per share'

"The 'C' stands for current earnings per share," he said. "So, our first basic rule in stock selection is that quarterly earnings per share should be up by at least 20 to 50 percent year to year."

A: 'Annual earnings per share'

"In our studies, the prior five-year average annual compounded earnings growth rate of outstanding performing stocks at their early emerging stage was 24%," he said. "Ideally, each year's earnings per share should show an increase over the prior year's earnings."

N – 'Something New'

"The 'new' can be a new product or service, a change in the industry, or new management," he said. "In our research we found that 95 percent of the greatest winners had something new that fell within these categories."

S – 'Shares outstanding'

"Ninety-five percent of the stocks that performed best in our studies had less than twenty-five million shares of capitalization during the period when they had their best performance," he said. "Many institutional investors handicap themselves by restricting their purchases to only large-capitalization companies."

L – 'Leader or laggard'

"So, another basic rule in stock selection is to pick the leading stocks — the ones with the high relative strength values — and avoid the laggard stocks," he said. "I tend to restrict purchases to companies with relative strength ranks above 80."

I – 'Institutional sponsorship'

"Leading stocks usually have institutional backing," he said. "However, although some institutional sponsorship is desired, excessive sponsorship is not, because it would be a source of large selling if anything went wrong with the company or the market in general."

M – 'Market'

"Three out of four stocks will go in the same direction as a significant move in the market averages," he said. "That is why you need to learn how to interpret price and volume on a daily basis for signs that the market has topped."

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