What is Cyclical Stock?

Key Highlights

• A cyclical stock is one whose price changes according to macroeconomic changes.
• The benefits of investing in cyclical shares include value opportunities, diversification, dividend income, etc.
• Car manufacturers, luxury goods makers, clothing stores, airlines, and hotels are cyclical stock examples.
• In times of low-interest rates, cyclical shares do well because they stimulate the economy. When interest rates rise, cyclical stocks do poorly.

Cyclical Stock Meaning

Cyclical stocks meaning refer to a stock whose price is affected by macroeconomic changes. They follow the cycles of an economy through expansion, peak, recession, and recovery. For instance, during a booming economy, consumers buy more consumer discretionary items, but during a recession, they spend less on them.

How Cyclical Stocks Work?

Cyclical stocks tend to do well when the economy is growing and not so well during economic downturns.

For example, when the economy is doing well, people have more money to spend, and they often buy new electronic gadgets. But during economic tough times, people tend to hold off on these big purchases.

That's why the earnings of companies in cyclical industries can go up and down a lot more than those in non-cyclical industries, which are less affected by changes in the economy.

If you can predict these economic cycles well, you might make a lot of money by investing in cyclical stocks. As economic ups and downs influence these stocks, they're riskier. Therefore, analyse your risk profile before you decide to invest.

Cyclical Stocks Examples

Here's a list of some examples of cyclical stocks based on different industries:

• Housing Industry: Companies like Lowe's, Home Depot, and PulteGroup.
• Automotive Industry: Includes Ford, General Motors, and Tesla.
• Travel and Leisure Industry: Companies like Marriott International, Delta Airlines, and Carnival Corporation.
• Retail Industry: Includes Nordstrom, Macy's, and Target. Industrial Manufacturing Industry: Companies like 3M, Caterpillar, and General Electric.

The revenues and profits of these companies can fluctuate with the economy. Also, these stocks are sensitive to economic changes. As a result, they are very unpredictable and risky.

Advantages of Cyclical Shares

Higher returns during expansion in the economy are the major benefit of these shares. The following are some other benefits of investing in cyclical shares:

• Value Opportunities When the economy is in a downturn, cyclical stocks can become undervalued. Investors can use this opportunity to identify stocks with strong fundamentals and long-term growth potential.
• Diversification Investing in cyclical shares can diversify your investment portfolio. By investing in industries that move differently from others, you reduce risk.
• Dividend Income Many cyclical companies pay dividends. These can provide a steady source of income whether the economy is doing well or facing challenges.
• Inflation Protection Some cyclical sectors, like commodities, can act as a hedge against inflation. Since their prices tend to rise when inflation increases.
• Growth Potential Cyclical shares have significant growth potential when the economy expands. Industries like construction and manufacturing often experience increased demand during economic upswings.

Disadvantages of Cyclical Shares

Despite their potential advantages, cyclical shares have some limitations. These are:

• Timing Accurately predicting changes in the business cycle and knowing when to invest in cyclical securities can be challenging. This difficulty can result in missed opportunities or losses for investors.
• Risk An investor may face increased risk and significant price fluctuations when investing in cyclical securities.
• Competition Competition within cyclical industries can be intense, leading to lower profit margins, price wars, and reduced earnings for companies operating in these sectors.
• Company-Specific Risks Cyclical companies are vulnerable to company-specific risks, such as technological advancements or shifts in consumer preferences. These factors can impact their earnings and stock prices.

Who Should Invest in the Cyclical Stocks?

An investor who is willing to take more risks should consider cyclical stocks. Additionally, it is a good investment option for those with a longer investment horizon.

These stocks can perform well during economic expansions, but they may become volatile during economic downturns. Therefore, investors must be patient enough to endure the ups and downs of the business cycle.

These stocks are excellent for investors who believe the economy will grow in the near future. In addition, cyclical companies must also be keen to take advantage of the same to increase earnings and revenues.

Nevertheless, you must be extremely cautious not to over-allocate to cyclical shares. They are subject to external factors outside of your control due to their unpredictable performance.

When to Invest in Cyclical Shares?

A keen understanding of business cycle fluctuations is essential to investing in cyclical shares.

Invest in cyclical shares during a recessionary phase. You can make significant capital gains during recovery as demand slowly picks up, which will affect the stock price positively. If capital gains are the goal of your investment, keep an eye out for adverse business cycle fluctuations.

Alternatively, investors looking for periodic dividends should invest in cyclical shares during the recovery phase of a business cycle, when stock prices gradually improve. During such times, cyclical companies are able to announce dividend payouts often due to the increase in sales levels.

Therefore, individuals who invest in cyclical shares should consider the current business cycle trends and expected rate of return on investment in order to maximise their profits. Due to stock market fluctuations, individuals should also consider the risk factor to ensure no financial strain is placed on them. When all these parameters are considered, a portfolio that is locked in for a long period is likely to produce extensive returns.

Conclusion

As we have understood, cyclical stocks are the ones whose prices are influenced by macroeconomic trends. Some of the cyclical sector examples are car manufacturers, luxury goods makers, etc. Moreover, investing in such stocks provides benefits of value opportunities, dividends, diversification, growth potential and inflation protection. However, it is risky as well due to the volatile nature of cyclical shares. Therefore, before investing in any stocks, ensure that you get expert advice, such as from Kotak Securities, who will help you make informed decisions.