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Don't Confuse Strategy with Outcome

I was recently asked about the CAN SLIM system, which has claimed substantial returns since its inception. As with any strategy claiming outstanding returns, this one requires a deeper look.

The CAN SLIM system was devised by William O'Neil, publisher of Investor's Business Daily and is based on evaluating seven characteristics. (Note that some of these characteristics are subjective.)

  • Current quarterly earnings
  • Annual earnings
  • New products or services
  • Supply and demand
  • Leading company in a leading industry
  • Institutional ownership
  • Market direction
According to the Investor's Business Daily Web site, the IBD 100 (which is an index of the top 100 stocks according to the CAN SLIM system) has trounced the S&P 500 Index 132.8 percent to 20.8 percentfor the S&P 500 since its May 2003 inception through yesterday. On Wikipedia is a more astonishing claim, with the American Association of Individual Investors reporting that portfolios trading according to the system had a total return of 1,351.3 percent from 1998 through 2008 without a single year of losses, compared to a 6 percent loss for the S&P 500 for the same period.

First, if something sounds too good to be true, it almost certainly is. The interesting question is this: If the system is so good, why isn't it better known? Why aren't such legendary investors as Warren Buffett and David Swensen using it?

Second, I learned long ago that while strategies have no costs, implementing them does. Because strategies have costs, we often see that they fail to deliver real world results that simulations suggest they might. Let's take a look at the CANSLIM system.

O'Neil has twice tried to run a mutual fund based on the system. He first tried in the '60s with some immediate success, but then the market crashed in 1968-69, taking his fund down as well. The fund had a total loss of -53.6 percent from 1969-74, compared with a loss of 18.8 percent for the S&P 500. O'Neil sold the fund in 1975 with just $6 million in assets, down from a peak of $49 million.

In 1992, O'Neil launched his New USA Growth Fund, which was managed by David Ryan, an O'Neil protégé who won the stock-picking contest known as the U.S. Investing Championship in 1985, 1986 and 1987. However, the fund showed lackluster results. According to Barron's, the fund had a total return of 3 percent from April 1992 through June 1994, versus 17.4 percent for the S&P 500. It met a quiet death as well, with O'Neil transferring the fund's assets to the MFS Emerging Growth Fund (MFEGX).

Finally, we have the CAN SLIM Select Growth Fund (CANGX), which was launched in late 2005. Despite the AAII claim of "gains made every year regardless of bull or bear market performance," CANGX lost money in both 2006 (-4.3 percent) and 2008 (-20.5 percent). Through June 30, 2010 it had lost 6.7 percent. And over the period from January 2006 through June 2010, the fund produced a total loss of just over 7 percent.

Morningstar classifies CANGX as a mid-cap growth fund. Thus, we can compare its performance to the MSCI US Midcap 450 Index. That index produced a total loss of just over 3 percent for the period. Once again, we see that achieving alpha is a lot more difficult than it might appear to be.

On Friday, we'll look at the results of a similar strategy: the Value Line Enigma.

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