Have you ever thought about why certain firms prosper in good times and yet find it hard to survive during bad times? The answer is whether they are cyclic or not. Knowing this difference is necessary for making intelligent choices concerning investment even in the most difficult economic situation.
To help you become a shrewd investor, this paper will delve into the key variations between cyclical and non-cyclical stocks at the individual level.
What Are Cyclical Stocks?
Cyclical stocks consist of firms, which have sales and profits dependent on economic expansion of the overall economy while their products or services are also highly sensitive to highs and lows in financial outlay.
Some typical examples of cyclical industries include:
- Automotive
- Airlines
- Luxury goods
- Home construction
- Recreational vehicles
- Furniture
During periods of economic growth and when people have confidence in their money, it is a common occurrence that companies which are cyclically-oriented do quite good because demand increases rapidly. Yet when the economic times get tough because customers no longer indulge themselves we find out that most of these firms have fallen greatly.
Characteristics of Cyclical Companies
Cyclical businesses have many same characteristics:
High fixed costs: Whether the sales volume is high or low, they will still have to spend large amounts of money on factories, machinery and workers as well
Capital Intensive: To drive future growth, these companies must keep putting their money in new projects, facilities, and product development.
Sensitive to Interest Rates: With higher borrowing costs, it becomes more expensive to finance operations and expansions.
Consumer Discretionary Focus: Usually, their products or services aren’t really essentials; they can be in danger of consumer’s spirit changes.
The cyclical firm’s performance may be compared with waves that continuously rise and fall in long-run economic changes.
Understanding Non-Cyclical Stocks
Conversely, non-cyclical stocks (also called defensive securities) are securities of businesses that vend products or render services whose demand remains constant irrespective of the performance of the general economy. Such firms are more likely to withstand economic downturns.
The industries that are not cyclical serve as the best examples of leading industries that have withstood many economic adversities throughout history.
- Consumer Staples (Food, Beverages, Household Goods)
- Utilities (Electric, Gas, Water)
- Healthcare (Pharmaceuticals, Health Insurance, Hospitals)
In difficult times, non-cyclical companies are still able to generate a stable income. Their growth prospects when the economy goes up are however low.
Diversifying with Non-Cyclicals
During difficult economic periods, a major advantage of Non-Cyclical Stocks is that they bring stability and therefore help in reducing portfolio related risk. When some of their investment is put in these defense names, investors will be hedging themselves against the cyclical sector’s risk volatility.
It is a worthwhile salute to the traditional illogicality of avoiding bottoming fishing in bear markets and searching for attractive prices in bullish markets, however foolish it may sound. Never forget that the best way to make money in the market is not to lose it in the first place.”— Martin Sosnoff (Atalanta Sosnoff Capital ).
Factors Influencing Cyclicality
Even though they seem easy job requirements by why nature, in actual reality, they are not. A company’s cyclicality ranges somewhere and it is determined by different situations that affect the supply and demand dynamics within that company’s industry:
Economic Growth: The primary driver of the expansion or contraction of economy is the general pace of it. Cyclicals benefit from healthy GDP growth which results into consumer and business expenditures surge.
Consumer Confidence:They will be more willing to make optional purchases that stimulate cyclical revenues if they feel that their financial situation and economic prospects are secure.
Interest Rates: Businesses and consumers benefit from low interest rates since they stimulate investment and big-ticket purchases which are advantageous to cyclic companies.
Government Regulation: Fresh policies or adjustments in regulations – that encourage or discourage commercial operations within specific areas are capable of deeply influencing periodicity.
To illustrate this concept, let’s examine a real-world case study:
Case Study: The Housing Crisis and Homebuilder Cyclicality
D.R. Horton (DHI) and Pulte Group (PHM) flourished, as they were dependent upon the economy in the United States improving in the early 2000s and attaining its peak in the middle of the same decade regarding the US Housing market. Nonetheless, when the subprime crisis hit US markets leading to reduced credit access coupled with a dramatic fall of real estate prices in 2007, these companies experienced extremely high reductions in share value due to the collapsing housing market. This was a clear example of how cyclical the two entities really were given that there was no more interest for building new houses
| Major Homebuilder Stock Performance | Peak to Trough (2005-2008) |
| D.R. Horton (DHI) | -88% |
| Pulte Group (PHM) | -95% |
| Lennar Corp (LEN) | -83% |
| KB Home (KBH) | -93% |
This example demonstrates how rapidly economic conditions can change, turning a flourishing cyclical sector into one that is dormant for many years.
Investment Strategies for Different Market Cycles
We understand cyclicality’s drive. Therefore, let’s examine how tree you can strategically invest in cyclic and non-cyclic equities with respect to broader economic cycle stage and position you self as an economic cycle general who nimbly modifies portfolio exposures:
Bull Market Approach
During a bull market when the economy is operating effectively, the stocks of cyclicals, which are those types of companies whose earnings are dependent on business cycles, are often likely to have high yield because they witness heavy demand for their products and services. This enables numerous cyclical companies to enjoy very strong earnings increases relative to average growth rates in the wider market.”
Some tips for bull market cyclical investing:
- Identify Market Leaders: Focus on companies that dominate their cyclical niche and have efficient operating models to maximize profit growth.
- New Product Cycles: Find cyclicals investing in innovative products that create new demand within their industry (e.g. new smartphone models, vehicle redesigns, etc.)
- Earlier Cycle Exposure: Cyclical stocks tend to experience their biggest gains earlier in an economic expansion before overheating concerns arise.
Bear Market Tactics
On the other hand, cycles businesses’ performance dwindles whenever there is a bear market since it erodes demand alongside pricing power. Thus, that is when some few non-cyclical, defensive shares are enabled to provide a necessary refuge for maintaining assets as creating stable income at the same time.
Smart approaches during downturns include:
- Dividend Growers: Seek out non-cyclical companies with long track records of consistently raising dividend payouts – a sign of financial strength.
- Low Debt Levels: Stick to defensive names with relatively low debt that allows them to maintain healthy cash flows even when the economy stalls.
- Discount Opportunities: Watch for chances to buy quality defensive stocks at attractive valuations amid the broader selloff.
Conclusion
The major importance of understanding the principal dissimilarities between cyclical and non-cyclical stocks has been shown by this guide, across all phases of the economic cycle. Cyclical stocks have a lot to offer when the going is good but they tend to be highly unpredictable and risky in times of economic slowdowns. However, non-cyclical stocks offer less excitement but they are more stable without that great potential for growth as in the case of cyclicals.
Investors cannot simply ‘set-and-forget’ their investment portfolios because different economic sectors tend to excel at specific points in time during any given business cycle. For this reason, one investment strategy might involve a diversified combination of exposure to both cyclical and non-cyclical stocks. A more advanced form of this approach would recommend investing more heavily in cyclical stocks early on then progressively switching to defensive assets such as bonds as the expansion phase matures.
In practice, it means investing more heavily in cyclical-oriented stocks early before shifting to bonds later as the growth phase peaks. Thus using such aggressive techniques will help ensure that you compound your riches continuously in the course of life.
FAQ,s
What is an example of a non-cyclical stock?
Procter & Gamble is a perfect instance of a non-cyclical stock. They are a picture of firms dealing with basic necessities; they have consistent results through all business cycles.
Is Apple a cyclical stock?
Procter & Gamble is an example of a non-cyclical stock. Firms that produce necessities are represented by this kind of stocks, and they consistently perform well irrespective of the economic situation.
How do you know if a stock is cyclical?
A company is defined as cyclic if its performance fluctuates with the state of the economy, increasing in times of prosperity and decreasing during recessions. This can be determined through observing the historical patterns of price movement and the belonging of its industry to consumer discretionary or materials.
What is a cyclical stock example?
An example of a cyclic stock is Ford Motor Company, whose performance goes up and down according to business cycles: doing very good while expanding and terribly during recessions.
