Cyclicals

Cyclical stocks are stocks whose value is closely tied to the business cycle and to the cycle of the domestic economy. Prices of cyclical move up when the economy is doing well, and back down when it is not doing so well. Cyclical stocks follow what is called a business cycle, which can last for years. Many businesses and industries experience cyclical movement in their sales, growth, and profitability through the years. As the national economy prospers, these industries tend to do very well. But when the economy takes a dive, cyclicals very often dive with it.

An Example of Cyclical Stocks

Auto companies are strong examples of cyclical companies. When the U.S. economy is booming, the domestic auto manufacturers have historically tended to do well. Their sales are high and they do not have to discount their products in order to move them. Their preferred stocks tend to pay out dividends in these time periods, and their shareholders are generally happy because the stock values tend to rise during these time periods, buoyed by consistent strong sales and earnings reports. In fact, auto stocks invariably respond to these reports every quarter, for better or worse. Their connection to the performance of the companies is very intimate and immediate, as shown by the average annual return on such products.

Successful Cyclical Investing

Given the fact that the national economy is cyclical in nature and has been shown again to follow a relatively predictable pattern of boom years followed by periods of slowdowns and recessions, it is therefore incumbent upon investors to use caution when investing in cyclical stocks. To do this kind of investing successfully, good timing is essential. Astute investors will scoop up cyclicals at the low point of the cycle or as close to it as possible, and then hold them until they recover and reach a high later on down the road.

If you buy these stocks just before an upturn, it is possible to make a lot of money. The problem is predicting the lows and highs. It is not always easy to pronounce that a stock has hit bottom. Investors can lose a lot of capital if they buy at the wrong point in the cycle, or they can be forced to wait longer to move these stocks, which in the meantime freeze cash that could be used to earn money elsewhere.

Cyclicals vs. Growth Stocks

It goes without saying that almost all companies do better when the economy is humming. But well built and well managed companies with an understanding of how to cope even in a down market will be able to withstand downturns much more successfully than others. The best growth companies, the ones that outperform the market and their industry year after year, are the ones that continue growing even when the economy and their industry as a whole are shrinking. Good growth companies are adaptive and can quickly react and adjust their approach to deal with changing economic conditions.

Cyclicals, on the other hand, are not positioned to be so responsive, and they are slower to adapt to changes in the marketplace. Their performance can be seen as a barometer of how the country is doing, because they only perform well when investors and consumers have pockets full of money to spend. But in a booming economy, these companies and their stocks can often outperform growth stocks by a wide margin. Their swings from losses to gains are often spectacular in nature. Buying cyclical stocks is only advised if investors are willing to lose the principal investment in exchange for the prospect of seeing that kind of spectacular gain.

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