Cyclical stocks are stocks whose price is influenced by a change in the macroeconomy. They follow the ebb and flow of the business cycles, which brings your revenue growth or shrinkage in tune with the state of the economy. Cyclical stocks are profitable during economic prosperity, but they are not so successful during downturns.
Cyclical stocks mainly include securities of those companies that provide consumer discretionary items. This implies that customers buy these items more during an economic boom when they have more income. On the contrary, the sale of these companies decreases in recession, when the spending capacity of their customers decrease.
To understand which stocks fall under this category, learn how to analyze stock fundamentals.
Let us now take a few examples of cyclical stocks.
What are the examples of cyclical stocks?
You can identify three broad delineations of cyclical stocks. The first includes durables, followed by the non-durables, and finally, services. Let us understand these in detail.
This category includes those companies which manufacture goods with a longer lifespan. For example, you can put the securities of automotive companies like Ford or appliance companies like Kelvinator in this category.
This category includes securities of those companies which produce soft goods with a limited lifespan. For example, adventure apparel companies like Quechua or retail services like Target fall under this category.
This category does not include commodity-producing companies. Rather, it includes stocks from companies that provide services. These include restaurant chains (such as Dominos), airlines (like AirAsia), hotel chains (like The Marriott), and so on.
To get a better understanding, let us compare these stocks to non-cyclical stocks.
You should know the notable differences between non-cyclical and cyclical stocks before you start investing. These are:
- Cyclical stocks are tricky to predict and hence risky, while non-cyclical stocks have a high-risk tolerance.
- The macroeconomic conditions heavily influence cyclical stocks, which is not the case with non-cyclical stocks.
Cyclical stocks offer greater potential returns than non-cyclical stocks during an economic boom. Whereas, in an economic slowdown, non-cyclical stocks perform better than cyclical ones.
- Cyclical stocks are from those companies which produce dispensable or non-dispensable goods and other luxury services. Non-cyclical stocks are from those companies which provide essentials, like water or hygiene products.
With more clarity in mind, let us now understand how to easily identify cyclical stocks.
Earnings per share and beta value are the most common indicators that help you identify cyclical stocks.
Being very economically sensitive, the earnings per share (EPS) of cyclical stocks vary significantly. To compare EPS and stock value, you can take a look at its price-to-earnings ratio. This ratio compares the earnings on a share to its market price, thereby giving a better idea of the returns you earn based on your investment. A lower value indicates the undervaluation of the company as cyclical stocks fluctuate with time.
It is a tool that measures the volatility of stock by keeping the rest of the market as the denominator. If you notice a beta value of more than one, it indicates higher volatility, which is a common characteristic of a cyclical stock.
Keeping these factors in mind, you can easily differentiate cyclical stocks from non-cyclical ones. However, when focusing on cyclical stocks, a few factors come into play that determines how well they will perform. Let us have a look at those.
Cyclical stocks perform best in periods of economic boom. They generate outstanding revenues and profit and can outperform their existing benchmarks. For instance, the value of cyclical stocks of airlines, hotel chains, and restaurants will rise in the holiday seasons and offer higher returns. However, as the holiday season comes to an end, these industries will switch to money-saving mode, squeezing the stock value.
Moreover, these stocks are volatile in nature and difficult to predict, which increases the risk involved with them. However, this makes cyclical stocks more interesting short-term trades because you can protect yourself against losses from your inactive stocks.
If you plan to invest in cyclical stocks, the best time would be when the economy is at its lowest. This will allow you to buy stocks at the minimum price, and you can take advantage of the economic cycle’s upswing.
Moreover, it is always best to opt for portfolio diversification to minimize your risks. For instance, you can create a mix of defensive and cyclical stocks, which will let you neutralize the overall risk involved with your portfolio. You can also choose other asset classes, like commodities or real estate funds to further expand into other sectors.
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The economy is dynamic and has constant ups and downs that directly influence cyclical stocks. So investing in these stocks is all about making your timing perfect. Before you start investing, make sure that you are well informed about the companies, their business cycles and potential threats and opportunities. Always keep your risk tolerance and investment goals in mind. Analyse the market movements and always be prepared for a range of economic scenarios, both good and bad. To get real-time updates directly on your phone, download the today!