In this study we look at William J. O’Neil’s work in AOL (presently TWX) in the late 90’s.
In 1965, William O’Neil bought a stock called Fairchild Camera. What happened next would teach him a painful yet valuable lesson. After the stock gained over 50% in a little more than a month, it corrected all the way back to its 50 day moving average. This made O’Neil, then in his early 30’s, nervous. After all, he didn’t want to lose the rest of his gains. So he sold his entire stake and locked in what profit he had left. Well, Fairchild ended up forming an ascending base pattern and went on to climb 200% without him. All O’Neil could do was watch. It so upset him that he never forgot it. And a good thing he didn’t….
Fast forward to 1998: like Charles Schwab, AOL was another imperfect cup with handle (makes sense, since they formed during the same market). Though AOL’s chart pattern was somewhat flawed, there was certainly nothing wrong with the fundamentals. In the previous three quarters, earnings had increased 130%, 900% and 283%; sales had accelerated 45%, 54% and 67%. Return on equity stood at 36%, more than double what it had been two years before; after-tax margins had also doubled. All of this had, of course, caught the attention of institutional investors. Mutual fund ownership in AOL jumped from 154 to 189 to 235 to 293 in the previous four quarters. And, to prove yet again that you get what you pay for in the market, the stock was trading over 150 times earnings at the time it broke out.
Like SCHW, AOL’s deep handle was the result of market conditions. The Nasdaq actually undercut its September low in October, yet both the handles of SCHW and AOL held well above the lows of their cups, a tell-tale sign of strength. Whereas SCHW broke out on 10/15/98, AOL broke out just eight sessions later: 10/27 (O’Neil was a busy beaver). In fact, according to Justin Neilsen (WON’s personal assistant), there were times O’Neil was 200% invested in only two stocks (AOL, SCHW, SUNW and QCOM were his big winners from that time). This incredible concentration helped him to enjoy his second best performance period ever: 1998, 401%; 1999, 322%.
O’Neil would add to his position in AOL twice, on 12/16/98 and then again on 3/11/99, as it emerged from an ascending base pattern; however, it was when AOL was forming this add-on base that his experience with Fairchild Camera came into play. Instead of panicking as AOL approached the 50 day moving average, O’Neil took a look at Fairchild’s 33-year-old chart and saw that it had indeed formed this precise pattern before continuing higher. AOL was behaving just as Fairchild had three decades before. This gave him the conviction to not only hold on to his AOL shares but to prepare to add to them.
Adding to this conviction was another precedent stock: Redman Industries. It had broken out of a thirteen week cup with handle pattern in March, 1968 on its way to a 767% gain in 12 months. O’Neil bought it correctly, but ended up getting shaken out when the market got choppy. He figured that was that. Redman went on to form an ascending base, however; unlike Fairchild Camera, he bought back in. From there it ran over 500% in 37 weeks.
Shortly after the 3/11 purchase, AOL went on a classic climax run, basically doing a double in about a month. O’Neil, seeing the end was near based on his studies of how stocks top, sold into this euphoria. When it was all said and done, AOL landed O’Neil a nice 456% gain. Nice work, if you can get it.
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