The O'Neil Strategy Picks Five Pricey Winners

This column was originally published on RealMoney on Sept. 26, 2007, at 11:34 a.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Those who have followed my recommendations know I pick stocks on the basis of automated strategies I created that use the variables cited by a number of well-known investors, such as Peter Lynch, David Dreman and Martin Zweig.

Many of these strategies have aspects in common, such as seeking reasonable price-to-earnings ratios so as not to overpay for the stock, and looking at growth to be sure the company's prospects are strong. But one of these strategies walks a different path from the others: the strategy I base on William O'Neil's writings.

This is particularly true when it comes to the price of a stock. Though the adage "buy low, sell high" is taken as scripture by many, the O'Neil strategy thinks differently. It likes to find stocks that are high today and have momentum behind them. The idea is that these are likely to break out into new territory in the future.

O'Neil is an accomplished investment theorist, technical analyst and founder of Investor's Business Daily. His approach of looking for stocks that are high-priced and likely to go higher gives a technical-analyst cast to his strategy. But he also looks at earnings growth and return on equity .

I have attended some of O'Neil's seminars and have read his books, and I find his approach intriguing. He does not look for "bargains," as so many others do. He believes that low-priced stocks are discounted for a reason -- they are inferior -- and that you are unlikely to make money in the long term by buying such stocks. Better to buy quality, he believes, and that means paying high prices.

You cannot expect to buy a top-quality suit or dress or an automobile that will serve you well for many years by paying bottom-dollar prices. Likewise with companies, O'Neil believes. The good companies have stocks that are relatively expensive, but if the company really is a high-quality business, such a price is worthwhile, because top companies are most likely to perform well in the long term. O'Neil has plenty of statistics to back up his approach.