CANSLIM Star Trader: An Interview with Gil Morales

Gil Morales, protege of William O'Neil and current principal and CEO of the money management firm Gil Morales & Company, is a self-described plunger. As we acquainted ourselves in preparation for our telephone interview earlier this spring, Morales was very much focused on the behavior of the markets and how that behavior was affecting his positions in a wide number of stocks.

"It's been very difficult for me actually because of the way I trade. I'm basically a plunger and when I come in, I come in heavy," Gil said, and then added "What year do you recall seeing three times where the market corrected 10% very quickly? You had the big sell-off at the end of February. Then you had the August sell-off, and then again in October."

Morales' career in the world of stock trading and investing began back in 1991 as a stockbroker in Beverly Hills. Moving to PaineWebber a few years later where he became a million dollar producer "in about three years" Morales was later recruited by William O'Neil himself to join his L.A.-based trading and investment company, William O'Neil and Company.

His time with William O'Neil helped him form both the methods and attitudes toward the market that he continues to abide by today. One of the foremost practitioners of O'Neil's CANSLIM approach to active investing and position trading, Morales has added a number of this own innovations to O'Neil's famous stock trading methodology. These included a greater willingness to bet against stocks when opportunities presented themselves, and a more conservative approach to adding new rules to already established trading methods.

Since 2007, Gil Morales has been the principal and CEO of Gil Morales & Company, LLC, (www.gilmoreport.com) a money management firm based in Century City, California.

We spoke with Gil Morales earlier this spring by telephone. What follows is Part One of our conversation with one of the most famous and successful traders and investors ever to come out of the "academy" that was William O'Neil & Company. Here, Gil talks about his early influences, the importance of "boxes and bases," and what he calls the Big Stock Principle.

David Penn: When we corresponded by e-mail, you mentioned four famous individuals who guided or inspired your approach to trading. Could you talk a little about these four people, who are probably traders all of us should know more about? I'm sure we'll talk a lot about William O'Neil. But what about the others? Nicholas Darvas, for example.

Gil Morales: I think I can summarize it. I could go on forever about these traders, but let's just boil it down to essential concepts. Darvas to me was the first guy
who really figured out bases and figured out that if a stock is moving within a consolidation or a base or a box as he called it, then it was doing what it should be doing.

So learning to interpret stocks within the realm of what is it doing, how should it be acting, was something I picked up from him.

Is it acting correctly? Fine. Hold the stock. And then if it does start to break out of the box or show some deleterious action within that box, maybe some heavy
volume selling that would throw it out of the box, then it's telling you something may be wrong.

Penn: Richard Wyckoff?

Morales: He to me was the first guy who recognized technicals. He said that fundamental analysis alone was insufficient because it lacked the basic element of
timing. And you couldn't make money just trading on fundamentals.

Wyckoff was really the first guy who looked at charts, I believe. He outlined the technical aspects of a stock's lifecycle: all the different labels on it showing how a stock has its big run, how it consolidates, sets up again and then finally gets to a top and a period of decline.

And so a lot of these concepts that Wyckoff outlines, particularly the technical aspects of the lifecycle of a stock, are basically part and parcel of William O'Neil's work on the long and the short side.

I think Wyckoff really contributed also the idea of supply and demand. The idea that price volume action is very important and that it's not necessarily a zero-sum game where every buyer is met by a seller was key. I mean there's also the element that every buyer may be met by one seller but if he wants to buy more stock he may not be able to find more buyers at a certain price point.

So there's the law of supply and demand coming into play that he discussed. I think that's also the essential part of O'Neil's work, that in certain stocks demand builds for them because you have a reason, a cause, which would be the fundamentals.

This is basically the company's position as an innovator with some sort of new product or service that is very compelling – combined with the institutions that have to own these stocks. There's a supply coming in and there just isn't enough of it out there for what they need to accumulate. And so it drives the price higher. In that sense the O'Neil view kind of extends from Wyckoff in that regard.

Penn: And the late great Jesse Livermore?

Morales: Jesse Livermore had this concept that I like which is the pivotal point. Not the pivot point. O'Neil calls it the pivot point. Livermore called it the pivotal
point, or more accurately described it as the line of least resistance.

Livermore had a number of rules regarding this sort of thing and one of the most famous to me is when he's talking about Anaconda Copper—I think it's around 1906 or 1907. Anaconda Copper was a big stock and everybody was playing it.

Livermore had a rule that when a stock went to a century mark, 100, 200, 300 or 400, it should go through that point and trade up 20 or 30 points. Very easily. Very quickly. And if it didn't something was wrong. And so to him those 100, 200, 300 points were lines of least resistance. So when a stock was able to get through there, it had to act a certain way coming through there to confirm to him that the stock was a buy and a hold.

In the book Reminiscences of a Stock Operator he talks on how he identified the market top. Anaconda Copper went to 300 and it could not hold at the 300 price level. And it reversed back down; it violated one of his rules with respect to the line of least resistance. It couldn't hold 300. And whereas it should have gone through and ran up very quickly, it didn't do that. And so it gave him a clue that the market was topping.

The other aspect of Livermore that I thought was very important is that he always felt you should be long in a bull market and short in a bear market. And anything else wasn't worth playing in.

Understanding those is definitely something that O'Neil picked up on and incorporated into his work. I think it's one of the major contributions of Livermore with respect to what I would call "O'Neilian Market Thought."

Penn: You mentioned a minute ago the idea of the big stocks and you referred to your investing style at least in part as following a big stock principle. Could you maybe elaborate on that a little?

Morales: Yeah. They have to weigh at least 200 pounds or, you know …

Penn: Bench 350.

Morales: Exactly. I think you just boil it down to this essential concept: We know there are institutional players. Now back in Livermore's day you had the pools. The investment pools. And they were the basic drivers of stocks. And he would sense their action.

What O'Neil does and what we did at O'Neil's company with respect to what I call the big stock principle was understand which stocks institutions have to own. If you're a growth-oriented manager, performance-oriented mutual fund or pension fund, there are certain stocks that exist in market that you have to own. You have no choice but to own them.

You have to own Apple when it's showing this huge growth because of the iPod and now the iPhone. You have to own Google when it's taking advantage of the Internet in ways that people really didn't think about.

One of the things that led me to Google back in August of '04 right after they came public was the fact that I saw Fidelity had filed a 13D showing they had a 13 percent position. I got to know Fidelity from working at O'Neil. We advised so we knew which organizations were smarter than others. And we know Fidelity, and they still are. They have an outstanding research organization and when you see a Fidelity contra fund come in and take a big position in a name like Google, well, you know they're not buying it to day trade it. They're buying it because they see something there that has a horizon of at least three to five years.

Penn: Right.

Morales: So you know two things: Number one, they're starting to accumulate it so they're maybe the driving force behind sending that stock higher. And number two, if they have a big position they have a stake in protecting that position, and they'll support the stock when it comes off. If you want to buy $2.00 goodies, some Canadian company turning oatmeal into oil and they've got a new financing deal coming through and you hear about this $2.00 thing … well, you're not going to get anywhere because the only other people that are going to drive that up are other fools who think it's a hot idea.

But you buy an Apple, you buy a Google, you buy Research in Motion and you know you have institutions behind you. So understanding which stocks in the market are companies that represent the cutting edge in what is going on in the economy at any given point in time is important.

You know what is their contribution to underlying conditions. We know that Apple's driving the whole movement of handheld devices both with the iPod and the iPhone into things that are much more than a phone.

It's this concept of what is driving the economy right now. Which companies are at the forefront? Which companies are at the cutting edge? Which companies are the big innovators within the economy? And going after these stocks because you know these institutions have to buy them.

Penn: Right.

Morales: In a bull market that's what drives them up. And that's the essence of the big stock principle. And it didn't really occur to me until late '98.

We were buying Schwab and AOL and I didn't think the bases were all that perfect. But it's sort of like an epiphany. I was buying these stocks as well and watching Bill O'Neil operate and the way he bought these stocks, and I realized what he was doing and why he can do it so fearlessly and so relentlessly—buying a million and a half shares of AOL. It was because he knew that the institutions were buying this and he knew these were big stocks.

And I remember him telling me, "AOL, that's a big stock." And when he said that to me it sort of all came to me that this concept of a big stock, this is exactly what it is. Buying that little $18.00 stock, that little tiny bank or whatever it is, you know, some little dinky software company making a medical software product, that's not it. It's the AOLs. It's the Googles. It's the Schwabs back in '98. The Qualcomms in '99/2000.

Those sorts of situations. And that's what the big stock is. I think qualitatively I think people can understand that.

Penn: Sure. You mentioned also a few minutes ago the idea of being in tune. These are stocks that are involved in the economy in a serious way. Apart from that aspect of the stocks, how much does pure economic or fundamental analysis play a role in your day-to-day decisions about whether or not you're buying a given stock?

Morales: We all know from Wyckoff that that's not going to solve your problem alone. But we do know from the O'Neil studies that there are certain fundamental characteristics that are prevalent in these stocks. And the primary one in my view is profitability.

One of the things you see in all these big winners is really a huge return on equity and that in turn drives huge sales growth, huge earnings growth. That's what you're looking for. You're looking for accelerating earnings growth. High double-digit, triple-digit earnings growth. Large five-year annual earnings growth. And, of course, new products.

Understanding what the product is because this all relates back to the big stock principle is important. What is the product? Where does it fit in the economy?
What's driving its sales? How badly do consumers need it?

So basically fundamentals in that regard are very important. A lot of people think O'Neil is just a technical system or a technician system, but it's not at all. It's
combining the two together in what I think is a very intelligently thought-out system.

Penn: Sure, sure.

Morales: And definitely Bill always told me that you have to understand your company in order not just to know the stock's going to have a big move. The more you understand the company and the more you are in tune with the products and where they sit in the economy and the kind of earnings growth they're able to generate, the better.

It also gives you a very important element when you're going to ride a stock for a big move, and that is conviction. So without conviction you're not going to hold something through a correction, a normal correction. But if you have a lot of conviction as a result of knowing where that company's place is within the economy and where their products fit in within the consumer mind or within the general economy, it helps you develop that conviction and helps you hold on for the big gain.

Click here to catch part 2 of our interview with Gil Morales.