Cyclical stocks, as the name suggests, are stocks that follows the ups and downs of the stock market in a cycle.
But how do we find cyclical stocks?
Searching for Cyclical stocks
Finding companies with cyclical stocks is pretty simple. These companies often belong to industry lines, such as automobile manufacturers, furniture, steel, airlines, paper, heavy machinery, hotels, and restaurants.
The profits and share prices of cyclical stocks usually follow the ups and downs of the economy, hence the name cyclical stocks.
When the economy is in full bloom, sales of cars, plane tickets, and luxury items tend to go up. However, cyclical stocks usually suffer when there is an economic downturn.
Investing in Cyclical Stocks
Because cyclical stocks tend to follow the ups and downs of the economy, timing is very important when investing in such assets.
You can make a lot of money if you do proper timing while you make your way into these stocks at the bottom of the down cycle just ahead of an upward move.
But if you enter at a wrong point in a cycle, you could lose a lot of money.
Cyclical Stocks vs. Growth Stocks
When the economy is booming, nearly all company are performing well. However, excellent growth companies tend to outperform even during the worst of market conditions. They still manage to clock in an increased earnings per share yearly.
During a downturn, these growth stocks may become slower than their long-term average. However, they still grow, which is an enduring feature.
On the other hand, cyclical stocks move more drastically than growth stocks in times of economic turbulence.
They can record huge losses during severe recessions. They can also have a hard time surviving until the next bullish market.
However, when things start to go north, they can quickly swing back from losses into profits, which usually can exceed expectations. Their performance during this time can even beat that of growth stocks.
How to Choose Cyclical Stocks
It’s not easy to predict an upswing in cyclical stocks. That’s particularly true because many cyclical stocks perform well months before the economy comes out of the recession.
Buying a cyclical stock requires a lot of research and courage. You should also be able to get your timing accurate.
Before you choose a cyclical stock, it’s best to select an industry that is poised to make a bounce. Within that industry, find companies that appear particularly appealing.
The largest companies are usually the safest and therefore best bets. The smaller companies may carry more risks, but it’s also possible for them to provide the most impressive results.
Many investors usually search for companies that have low price-to-earnings multiples. However, this strategy doesn’t really sit well with cyclical stocks.
The earnings of cyclical stocks fluctuate too much. That means the p/e ratio isn’t a suitable metric. Also, cyclical stocks with low p/e ratios can often turn out to be a risky investment.
A high p/e typically signals the bottom of the cycle, while a low ratio often indicates the end of an upturn.