CANSLIM Strategy – Backtesting and Insights 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:

Table of contents:

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