What Are Cyclical Stocks?
Cyclical stocks refer to companies whose revenues and profits are tied in with the ups and downs of the economy, also known as the business cycle. These companies tend to do better when the economy is healthy, then fall when the economy is sluggish. Cyclical stocks are a strong predictor of how the overall economy is doing, and therefore, a good tool for savvy investors to have in their kit.
Understanding the Basics of Cyclical Stocks
Whether you are a new or experienced investor, having a strong understanding of what cyclical stocks are is critical before investing in them. Because of their relationship to the business cycle, cyclical stocks can offer investors both high returns and losses depending on what part of the economic cycle they are in.
Cyclical stocks also tend to be less predictable and more volatile than non-cyclical stocks, making them riskier investments.
The Types of Companies That Are Considered Cyclical
There are many different types of businesses that can be classified as cyclical, but the following are those that are typically considered to be so:
•Auto manufacturers
•Construction companies
•Airlines
•Department stores
•Hotel & hospitality companies
•Retailers
•Travel-related businesses
•Commodity producers
•Appliance makers
•Homebuilders
•Technology industry companies
•Entertainment industry companies
•Transportation industry companies
Benefits of Investing in Cyclical Stocks
The primary benefit of investing in cyclical stocks is the potential for high returns when the economy is booming. During periods of economic growth, companies in these industries are often able to capitalize on an increased demand, allowing them to sell more of their products at a higher price. This can lead to higher profits and subsequently higher stock prices.
When compared to non-cyclical stocks, the returns on cyclical stocks tend to be far higher. Additionally, because these stocks are typically less reliable in terms of performance compared to non-cyclical stocks, investors may be able to purchase them at lower prices than they would otherwise be able to purchase similar non-cyclical stocks.
Risks Associated With Investing in Cyclical Stocks
As with any investments, there are risks associated with investing in cyclical stocks. One of the biggest risks associated with investing in cyclical stocks is their tendency to be more volatile than non-cyclical stocks. This means that the value of cyclical stock investments can fluctuate more quickly and without warning, leading to faster losses.
Another risk associated with cyclical stocks is that they tend to suffer more significantly during periods of economic downturns. During such periods, the demand for goods and services typically falls, leading to lower profits and stock prices for cyclical stocks. Finally, since cyclical companies often have to invest more in research and development to stay on top of the competition and supply the right product at the right time, they may not have the same level of long-term sustainability as non-cyclical stocks.
How to Invest in Cyclical Stocks
Investors who are hoping to take advantage of the returns that cyclical stocks have to offer should invest in them in the form of a diversified portfolio. This means that they should invest in a variety of different cyclical stocks, so that if one or two stocks in the portfolio experience a downturn, the portfolio’s overall performance is still less impacted.
To further diversify, investors may wish to purchase a combination of both cyclical and non-cyclical stocks, so that their portfolio is not highly dependent on one type of stock.
Cyclical stocks are an important tool for savvy investors, as they often provide higher returns and can be a great predictor of the overall economic cycle. While investing in cyclical stocks comes with great rewards, it is important to note that they can be more volatile and unpredictable than non-cyclical stocks. Therefore, it is essential for investors to have a strong understanding of what cyclical stocks are and how to invest in them responsibly before diving into the market. The best way to ensure that investors are able to capitalize on the rewards offered by cyclical stocks is to create a diversified portfolio with a mix of both cyclical and non-cyclical stocks.
