In the stock market, there are a plethora of different companies listed and trading every single day. The stocks of these listed companies can be broadly classified into two categories – cyclical stocks and non-cyclical stocks. Let’s delve a little deeper into the first category and try to understand what cyclical stocks are and how they impact you as an investor.
But before that, we’ll first quickly take a look at how an economy works. The economy of a country has 4 broad phases – expansion, peak, recession, and recovery. A country typically goes through all of these 4 phases in a cyclical manner. Now that you know the trajectory of an economy, let’s get back to answering the question ‘what is a cyclical stock?’
What is a cyclical stock?
A stock whose price follows the path of the economic cycle is commonly referred to as a cyclical stock. The price of such a stock is affected by macroeconomic factors like the economic performance of a country. For instance, the price of a cyclical stock is likely to witness a meteoric rise during the expansion and peak phases of the economic cycle. Similarly, when the economy is in recession and recovery modes, the price of such a stock is likely to fall and languish.
Companies that are considered to be cyclical stocks are involved in the manufacture of products that are typically considered to be non-essential to the consumers. Consumers tend to only purchase these goods if they have adequate disposable income on their hands.
This is one of the primary reasons why the sale of products manufactured by cyclical stock companies experiences a boom when the economy of the country is doing well. On the other hand, when the economy is in a recession, consumers tend to spend less and save more. This directly leads to a fall in the sale of the products manufactured by cyclical stock companies.
Companies that are involved in the manufacture of automobiles like cars and motorcycles are great cyclical stocks examples. Consumers tend to buy cars only when the economy is doing well since they have more disposable income. During periods of recession and recovery, automobile companies usually experience dwindling or little to no sales.
In addition to automobile manufacturing companies, there are several other cyclical stocks examples. Here are some of them.
– Real estate developers
– Cement manufacturers
– Luxury goods manufacturers
– Hotels and restaurants
– Large-scale clothing stores and other retailers
Advantages of cyclical stocks
Now that you know the answer to the question ‘what is a cyclical stock?’, let’s move forward and take a quick peek at some of the advantages of these stocks.
They generate good returns
One of the major advantages of cyclical stocks is that the returns generated by these companies are significantly higher during times of economic boom. These companies generally tend to outperform even the broad market indices. Additionally, with cyclical stock companies, the potential for future growth is also that much higher.
Their performance can be easily predicted
Predicting the performance of cyclical stock companies is far easier than predicting that of non-cyclical companies. A well-established company with a strong product portfolio would almost always perform well when the economy expands or hits a peak. All that you need to look out for are the macroeconomic factors of the country.
So, now that you’ve seen cyclical stocks examples and the advantages that they come with, should you, as an investor, invest in cyclical stocks? The answer to this question is not very simple. While they can give you good returns on your investment, they’re also quite volatile and prone to unpredictable changes in their stock price. That’s not all, the level of risk is also higher with cyclical stocks. During periods of economic recession, such companies are likely to experience a dramatic fall in their share prices, which can end up hurting your investment portfolio.
That said, it would not be entirely prudent for you to not invest in cyclical stocks. Since cyclical stocks are closely linked with the economy, you can invest in these companies for the short term during periods of economic well-being. Furthermore, you could also diversify your risk by having an adequate mix of both cyclical and non-cyclical stocks in your portfolio.