In economic terms, cyclical stocks are stocks whose price is affected by macroeconomic changes. These stocks follow an economy’s expansions, peaks, recessions, and recoveries. The majority of cyclical stocks are companies that sell consumer goods, such as clothes and electronics, which consumers buy more during times of economic boom and spend less during times of recession.
Investors buy these stocks at the low point of a business cycle and sell them when the cycle reaches its peak.
Understanding Cyclical Stocks
Companies such as car manufacturers, luxury goods makers, clothing store owners, airlines, and hotels can be characterized as cyclical since they see sales booms when economies are strong and suffer when economies are slow. The stocks of cyclical companies can become worthless during a severe recession to cause the company to go out of business.
An economy that is booming increases the profits of these companies because consumers are spending more money on these products, as was the case in India from 2004 to 2007. During a recession or slowdown, their profits decline due to decreased consumer spending.
Cyclical stocks can be judged using various indicators.
|Indicator||Beta Value||Earnings Per Share (EPS)||Price-Earning Ratio (PE)|
|Description||A cyclical is likely to have a high Beta Value, which is usually greater than 1. Stocks with a Beta of 1.5 falls 15% if the market falls 10%.||Cyclical stocks have fluctuating Earnings Per Share (EPS) since the economy’s mood affects their earnings.||Price-Earnings ratio (PE) compares the share price with the earnings per share. The PE ratios of cyclical are generally lower, making them cheaper than defensive stocks.|
The weight of cyclical stocks in an investor’s portfolio should be managed with caution at any given point in time. Despite that, investors do not necessarily need to stay away from these stocks altogether.
Example of Cyclical Stocks
Circular stocks are often further categorized as durable, nondurable, and service stocks.
- Durable Goods
Manufacturing or distribution of physical goods that will last more than three years constitutes the activities of durable goods companies. These companies include automakers such as Ford, appliance makers such as Whirlpool, and furniture companies such as Ethan Allen.
Indicators of future economic performance include durable goods orders. It may indicate stronger economic activity in the ensuing months when durable goods orders are up in a given month.
- Nondurable Goods
The nondurable goods industry produces and distributes soft goods with a life expectancy of fewer than three years. Sports apparel manufacturer Nike and retail stores like Nordstrom and Target are examples of companies that operate in this segment.
Cyclical stocks in the services sector are different because these firms do not produce or distribute physical goods. In contrast, they facilitate a range of leisure activities for consumers, including leisure travel and entertainment.
A well-known company in this field is Walt Disney (DIS). Additionally, companies that operate in the new digital area of streaming media, such as Netflix (NFLX), are included in this group.
While it is not feasible to list every cyclical industry, below are eight prominent and easy-to-understand examples of sectors that are susceptible to cyclicality:
- Airlines: In economic boom periods, individuals and businesses are more likely to spend money on airline tickets than during economic gloom.
- Hotels: Much like airlines, hotels rely on consumers and businesses making payments for travel.
- Retail: When the economy is contracting, consumers tend to spend less on discretionary purchases. In contrast, retailers who sell primarily what people need aren’t very cyclical, especially when they offer discounts. Interestingly, Walmart can even be considered countercyclical because the company increases sales during challenging times.
- Restaurants: People tend to eat at home more frequently in times of economic distress, which hurts restaurant stocks.
- Automakers: Consumers tend to hold on to their cars longer during recessions and purchase new vehicles more often during prosperous times, so automotive stock prices tend to be very cyclical.
- Technology: The markets for tech stocks are generally cyclical (but not always). When the economy is in a slump, businesses and individuals are less likely to spend on the latest technology and electronic devices.
- Banks: During a recession, bank profitability typically decreases. Consumers who already have loans find it more challenging to pay them back during recessions, which reduces demand for banking products such as mortgages, auto loans, and credit cards. Furthermore, banks’ profit margins tend to contract before and during recessions due to falling interest rates.
- Manufacturing: Companies that manufacture physical products tend to experience plunging sales when people and businesses are spending less on pretty much everything.
As mentioned above, many of the sectors included in the consumer cyclical sector are consumer-facing industries, such as automotive and retail. Contrary to consumer staples, consumer cyclical isn’t strictly necessary purchases since they are discretionary goods.
Recessions and economic downturns usually differ from one another. A number of the industries mentioned above have been adversely affected by COVID-19 — for example, banking and retail. As people have stayed home due to the pandemic, technology stocks have performed incredibly well, and many tech companies have either benefited or remained relatively unaffected.
Cyclical vs. Noncyclical Stocks
Economic conditions tend to influence cyclical stock performance. On the other hand, noncyclical stocks don’t tend to be affected by economic conditions. Stocks such as these often outperform the market regardless of economic trend, even when the economy slows down.
A non-cyclical stock is also referred to as a defensive stock. All types of business cycles and economic downturns have led to continued demand for these stocks, which are categorized as consumer staples.
Noncyclical stocks include companies such as Walmart that deal with food, gas, and water. Investors may be able to benefit from adding noncyclical stocks to their portfolios during an economic downturn since they can help offset losses caused by cyclical companies.
During economic downturns, cyclical stocks tend to be more volatile than noncyclical stocks or defensive stocks. During stronger economic times, however, they tend to outperform the market. The best investors balance their portfolios with a mix of cyclical and defensive stocks for long-term growth and low volatility.
In addition to gaining exposure to cyclical stocks, investors often invest in exchange-traded funds (ETFs) to extend economic cycles. Consumer Discretionary Select Sector Fund (XLY) is one of the most popular cyclical ETF investments in the SPDR ETF series.
Therefore, if you are on the verge of deciding whether to put your bank on these stocks, it’s good to consider mixing both cyclical and non-cyclical for the best outcome!
Curious about other ways you can boost your portfolio? Read our article on Blue Chip Stocks, and why it’s beneficial to add them to your portfolio!
Best Cyclical Stocks For 2021
Cyclical stocks are flourishing in 2021 with the reopening of the economy and the rollout of vaccines. As of April 28, GuruFocus’ All-in-One Screener listed the following consumer cyclical companies as being popular with gurus.
We recommend five cyclical stocks for the post-pandemic era:
- The Home Depot
The Home Depot Inc. (HD), a home improvement specialty retail chain, has a market capitalization of $233.9 billion. In the past ten years, the company’s revenue grew by 5.7%.
Ken Fisher holds 0.57% of the outstanding shares, Pioneer Investments owns 0.49% of the company, and Spiros Segalas’ Harbor Capital Appreciation Fund holds 0.16%.
According to the most recent price-earnings ratio, the stock was trading at 21.75 as of April 28. With shares trading at $217.76, the stock was 11.97% below its 52-week high and 54.85% above its 52-week low. This represents a gain of 512.37% in the past ten years.
Market capitalization for Tesla Inc. (TSLA) is 147.28 billion dollars. In the past ten years, the company’s revenue has grown by 82.80%.
The company has 11 gurus invested in it. Jim Simons’ Renaissance Technologies holds the largest stake, holding 2.14% of outstanding shares. Ron Baron owns 0.88%, and PRIMECAP Management owns 0.83%.
At the close of trading on April 28, the price-book ratio was 21.75. Shares of the company were trading at $798.75, which was 17.57% below the 52-week high and 351.29% above its 52-week low. Its stock price has risen 3,243% since the turn of the century.
With a market cap of $138.97 billion, Nike Inc. (NKE) has the fifth-largest market cap in the world. Since 2010, Nike’s revenue has increased by 8.10%.
19 gurus own the athletic footwear and apparel brand. There are four major guru shareholders: Frank Sands owns 0.44% of the outstanding shares, Segalas owns 0.43%, Pioneer Investments owns 0.19%, and Steven Cohen’s Point72 Asset Management holds 0.10%.
The Price-earnings ratio for the shares was 32.98 as of April 28. At $89.37, the stock was 15.39% below its 52-week high and 48.95% above its 52-week low. This represents a 360% return over ten years.
McDonald’s Corp. (MCD) has an estimated market capitalization of $138.21 billion. During the past decade, revenues have fallen 1.60 %.
The stock is held by 13 gurus. The company’s largest guru shareholder is Pioneer Investments, which holds 0.19% of outstanding shares. T Rowe Price Equity Income Fund holds 0.03%, followed by PRIMECAP Management with 0.02%.
During the week ending April 28, the stock traded at a 23.59 price-earnings ratio. Shares of the company traded at $185.89, which was 16.24% below the 52-week high and 49.63% above the 52-week low. Since the start of the decade, the stock has gained 159.91%.
The market capitalization of Starbucks Corporation (SBUX) is $91.24 billion. In the last decade, Starbucks’ revenue increased 11%.
Stocks in the company are owned by 16 gurus. With 0.47% of outstanding shares, Bill Ackman’s Pershing Square Capital is the company’s largest guru shareholder, followed by Simons’ firm with 0.42%, Pioneer Investments with 0.13%, and Steven Cohen with 0.07%.
Shares of the company traded at $77.74 on April 28, 22.04% below the 52-week high and 55.42% ahead of the 52-week low. The company’s stocks are traded at a price-earnings ratio of 25.41. Over the past decade, its shares have gained 484%.
You can never be 100% certain about how the market is performing since investing in stocks entails a careful examination of market behavior. As a result, it’s crucial to keep an eye out for the best stocks to invest in at all times, and you can do so by clicking the following link!
Interested in how the stock market is doing overall? Check out our Ultimate Stock Market Predictions for 2021!
How Investors Can Benefit from Cyclical Stocks
Ideally, an effective investment strategy would be to purchase cyclical stocks at the start of an economic expansion and to sell them just before a recession starts. It is impossible, however, to anticipate the timing of recessions or expansions.
Combining defensive stocks with cyclical stocks makes more sense in your portfolio. As a result, you will prosper when the economy is growing and be protected when the economy contracts.
Despite their decline in recessions, these stocks are said to be beneficial to those with the right level of risk tolerance. The average recession lasts 18 months, at least historically, and happens once every ten years. The more you are tolerant of volatility, the more likely you are to win.
Nevertheless, buying cyclical stocks is not necessary to get good returns. For example, Goldman Sachs reports that the average annual return for the S&P 500, which monitors the entire stock market, has been 13.6% for the past ten years. Thus, investing in low-cost index funds that track the S&P 500 may offer similar long-term rewards than trying to time the market for many long-term investors, such as those saving for retirement.
Cyclical stocks encourage investment behavior that is very close to market timing, which is one of the main problems of investing in them. In addition, cyclical stocks are easy to get scared about, resulting in a loss when you sell low rather than staying the course.
However, we recommend taking a step back and focusing on stocks from companies with excellent prospects that you can feel confident about owning for years to come without trying to follow cycles.
For more tips on stock trading, check out our beginner’s guide!
Furthermore, as everyone knows, COVID19 has also affected these stocks, so we recommend digging a little deeper if you would like to learn what other considerations you should take when investing. Investing in Cyclical Stocks: Has the Pandemic Changed the Outlook? is one great guide that might lead you on the right track!
Regardless of what method you decide to use, cyclical investing requires a certain level of patience. A market cycle can last many years, even decades. Even though timing the market has always been a challenge, the sheer length of these cycles makes it even more difficult. Since recessions or economic downturns can go on for years before recovery occurs, you should be prepared to hold stocks in cyclical companies for the long term if necessary.
Partner at Vega Capital Management - a private funds management company.
An experienced portfolio manager with 10+ years of proven and reputable track record in investment management and financial analysis. Currently, a partner at one of the fastest-growing private fund management companies in southeast Europe, Kiril has been tending to a loyal international base of client-investors and partners. When he is not crunching numbers and increasing his client’s wealth, he reminisces about his Michelin-star restaurant cheffing years and fondness of the culinary arts.