Lecture 7

Investment Strategy II
Economics 98 / 198 DeCal Fall 2007
Announcements

• Homework due next week

• Also, attach trading history to your paper
Current Events
Lecture Content
Last Week

• Introduction to investment strategies

• Qualitative vs. Quantitative Analysis
• Fundamental vs. Technical Analysis
• Value vs. Growth Investing

• Fundamental Analysis
• Qualitative Aspects (Understanding the business,
competitive advantages, industry, management, etc.)

• Value Investing
• Buying stocks that are valued below its intrinsic value
• Using various financial ratios and measures
Today

• Growth Investing

• CAN SLIM
• C = Current Quarterly Earnings per share
• A = Annual Earnings Increases
• N = New Products, Managements, Highs
• S = Supply and Demand
• L = Leader or Laggard
• I = Institutional Sponsorship
• M = Market Direction
 GROWTH
INVESTING
Growth Investing

• Buy stocks that expected to grow quickly

in sales and earnings (relative to industry
and market)

• Underlying quality of the business and the

rate at which it is growing
• Usually newer companies, industries, and
markets
• Will usually have a higher P/E. Why?
Growth Investing

• No automatic formula for determining best

growth stocks

• General guidelines
• Strong historical earnings growth
• Strong forward earnings growth
• Management control of costs and revenues
• Company efficiency
• Innovative products / industry
 CAN SLIM
INVESTING
CAN SLIM Background

• Developed by William O’Neil

• Developed from studies on greatest

stock winners of all time
• Provides solid guidelines to prevent
subjectivity
• Combination of growth, fundamental,
technical analysis
 CAN SLIM Performance
1998 - 2005
860.30%

28.60%

CAN SLIM S&P 500

Source: American Association of Individual Investors

C = Current Quarterly EPS

• Bottom line counts - major % increase

in current quarter EPS (25% or more)

• Look for accelerating growth

• What does this mean?

• Should be supported by sales growth

(revenue) – Why?
C = Current Quarterly EPS
Examples

• Cisco Systems – EPS gains of 150%

and 155% in 2 quarters prior to 1467%
run-up over next three years

• AOL – EPS gains of 900% and 283%

before rising 557% in 6 months

• Dell – 74% and 108% before rising

1780% in 27 months in November
1996
Resource for Quarterly Earnings: MSN Money

Revenue Figures
(Calculate growth
rates yourself)

EPS Growth Rates

(Year over Year)
(Eg. Q1 ‘04 vs Q1 ‘05)
A = Annual Earnings

• Annual earnings growth 25% or

more over past 3 – 5 years
• ROE at least 17% or higher

As O’Neil says, "who wants to own

part of an establishment showing
no growth"?

Why is annual growth vs. quarterly

growth important?
A = Annual Earnings
Example

Xerox
• earnings growth rate 32% before
soaring 700% in 1963-1966

Wal-Mart
• 43% annual EPS growth before
rocketing 11,200% from 1977 to 1990

Cisco (257%) and Microsoft (99%)

Resource for Quarterly Earnings: MSN Money

Annual
Earnings Per
Share
N = New products, management, highs

• Takes something new to produce

startling advances in price of stock
(ideas, products, services, etc.)

• Apple
• Abercrombie
• Cisco
• Charles Schwab
• Taser
• Sunpower
N = New products, management, highs

• Buy stocks when emerge from

consolidations patterns and make
new highs (technical analysis)

“Buy low, sell high”

vs.

“Buy high, sell higher”

S = Supply and Demand

• Law of supply and demand

determines price of almost
everything
This is where technical
analysis comes into play

Want to buy stocks that are

being bought by institutions
(importance of volume)
L = Leader or Laggard

• Narrow down selection to best

industries / sectors of stock market
• Narrow further by selecting best
companies in the industry

• Best doesn’t mean

the biggest or
most well-known
L = Leader or Laggard

• New leaders every cycle

• 1999-2000 Tech, Telecom
• 2002-2004 Real Estate, Energy, Retail
• 2004-Present Foreign, ???

• Look for companies that withstand

downturns in market the best
• What does this mean?

• Criteria:
• Earnings / sales growth, ROE, margins, etc.
A Tool for Industry Research / Rankings: Stockcharts.com Industry Tool
<http://stockcharts.com/charts/performance/perf.html?$BKX,$XAU,$SOX,$OSX,$DRG,
$GSPMS,$DOT,$BTK,$XBD>
A Tool for Industry Research / Rankings: Investor’s Business Daily
A Tool for Industry Research / Rankings: www.prophet.net

Rank Industries
by Performance
over Various
Periods

Click on the chart

box to get charts
for all companies
within the
industry
I = Institutional Sponsorship

• Want to own stocks significantly owned

by top institutions
• Institutions: mutual funds, pension funds,
hedge funds, banks, universities
• Can account for up to 70% of trading
activity
I = Institutional Sponsorship

Institutional
Investors
Individual - Mutual Funds
Investors - Hedge Funds
- You - Pension Funds
- Me - Educational
- Parents Institutions
- Uncle Joe - Bank Trusts
A Tool for Institutional Sponsorship: MSN Money
(http://moneycentral.msn.com/ownership)

Mutual Fund
Ownership

Ownership
Activity

Specific
Mutual Funds
Ownership
(with links to fund
quotes)
M = Market Direction

• You can be right about everything,

but if you’re wrong about where
market is heading…

Why?
M = Market Direction

• Importance of following the market

• It can be done! (Next lecture)
• Bull market vs. Bear market

• Myth of Long-Term “Buy-and-hold” Investing

• 33% loss requires 50% gain to break even

• 50% loss requires 100% gain to break even
M = Market Direction

• Stay out in cash during bear markets

and invest during bull markets

• Don’t try to anticipate the market

(gambling)
• Instead, let market guide you

• How to do this? (next lecture)

CAN SLIM Overall Strategy

• Narrow your selection (watch list) of

stocks through fundamental analysis
• Use technical analysis (charts) to
determine when to buy into stock and sell
out

• Don’t buy stock just b/c of low price

• You don’t make money on how many shares you
own, but by how much money is invested

• Do not let small losses turn into large

ones (cut losses early)
Homework / Reading

• Paper: Complete by next week

• Reading:
• Investopedia. Introduction to Support &
Resistance