Here are some of the popular cyclical stocks in India
- HEG Ltd
- Graphite India Ltd
- NBCC (India) Ltd
- Honeywell Automation India Ltd
- Shree Cement Ltd
- JK Lakshmi Cement Ltd.
- Kajaria Ceramics Ltd.
- The Phoenix Mills Ltd.
- MOIL Ltd.
- Maharashtra Seamless Ltd.
What are cyclical stocks
Cyclical stocks, closely tied to the economic cycle, fluctuate in value as the economy expands and contracts. These stocks, often linked to consumer discretionary goods, perform well during economic booms and poorly during recessions.
In this comprehensive guide, we'll delve into the world of cyclical stocks, covering their key characteristics, advantages, drawbacks, tax implications, and suitability for different investors. We'll also explore the optimal timing for investing in these stocks and differentiate them from non-cyclical stocks.
Whether you're a seasoned investor or just starting out, this guide will provide valuable insights to help you make informed investment decisions.
Think about firms that target discretionary income, such as luxury labels, travel agencies, hotel chains, and automakers. Consumers indulge in these luxury products and services while the economy is doing well. However, when uncertainty grows — such as rising inflation or during a recession — consumers’ budgets get tighter, and their desire for these kinds of luxuries tends to decrease.
How cyclical stocks work?
Cyclical stocks thrive during economic expansions and struggle during recessions. For example, demand for electronics surges during economic booms as consumers have more disposable income. However, during downturns, demand declines as consumers postpone major purchases.
Cyclical companies, therefore, experience greater earnings volatility compared to non-cyclical companies, which operate in industries less sensitive to economic cycles.
While cyclical stocks offer the potential for significant returns if economic cycles can be accurately predicted, they also carry higher risk. It's crucial to assess your risk tolerance before investing in these stocks.
Features of cyclical stocks
Here are the features of cyclical stocks-
Stock prices follow a trend
These stocks fly on the wings of prosperity during economic growth. On the other hand, they reflect a downward swing in economic slowdowns, reflecting the general pessimism in the market.
High beta
Beta is a useful indicator for investors to determine the degree of risk associated with a certain stock in comparison to the overall market. It enables investors to understand how much a stock's price may move in reaction to market conditions. Cyclical equities have a high beta, which increases their vulnerability to market fluctuations.
Volatile earnings
Cyclical shares see earnings that fluctuate in tandem with the state of the economy — rising more during market upswings but falling further during downturns.
Low price-to-earnings
Investing in cyclical firms yields lower price-to-earnings ratios than non-cyclical equities. Their appealing nature is offset by market downturns when investors avoid long-term obligations and their PE multiples decline.
When should you invest in cyclical stocks
Investing in cyclical stocks needs careful timing. The best time to buy these equities is in the early stages of an economic upturn. This is when businesses in cyclical sectors often start to succeed, paving the way for possible stock price increases. One has to be on the lookout for indications of an economic recovery to capitalise on the success wave. For example, higher government spending on infrastructure projects might indicate economic growth.
Factors to consider before investing in cyclical stocks
- Company's fundamentals: Evaluate the company's cash flow, debt levels, profit margins, and revenue growth. Resilience during economic downturns is ensured by a solid foundation.
- PE ratio comparison: Evaluate the company's PE ratio in relation to industry norms and peers. Even if a cheap PE might appear appealing, it's important to be aware of the underlying risk factors.
- Interest rate impact: Think about the current landscape of interest rates. Since low or declining interest rates encourage economic expansion, cyclical companies do well during these times.
- Economic indicators: Pay attention to changes in consumer spending trends, business capital investment, and government policy. These metrics provide information about the economic cycle's stage as well as prospective investment possibilities.
- Market timing: Choosing the right moment to invest in cyclical stocks is essential. Try to get into the market in the earliest phases of economic growth and get out before a bust. But be prepared to adjust when the market conditions change.
Who should invest in cyclical stocks
These stocks might be the key to realising your financial goals if you have the resilience to withstand market turbulence and the foresight to recognise economic trends. In other words, a high-risk appetite and strong research and analytical skills become prerequisites. But proceed with caution, as this can be a risky excursion.
Advantages and disadvantages of cyclical stocks
Here are the advantages and disadvantages of cyclical stocks
Advantages:
- High return potential: During times of economic expansion, cyclical stocks have a chance for substantial profits.
- Clear identification: Because they are part of sectors that depend on discretionary expenditure, cyclical equities are simple to identify.
- Liquidity: Because cyclical equities are popular, they often have high liquidity, making it simple for investors to acquire and sell shares.
Disadvantages:
- High risk: Compared to non-cyclical equities, cyclical stocks are more risky due to their inherent volatility.
- Uncertainty: Stock prices can fluctuate depending on several factors, including market movements and customer sentiment.
- Market timing dependency: During recessions, poorly timed investments can lead to significant losses or lost opportunities.
Cyclical vs. Non-cyclical stocks
Here are the main differences between cyclical and non-cyclical stocks-
Point of difference
|
Cyclical stocks
|
Non-cyclical stocks
|
Product offering
|
Discretionary goods and services for consumers. For instance, phones, computers, air travel, and hotel expenses
|
Necessities. For example, water, electricity, and basic food commodities like wheat, rice, and salt
|
Industries
|
Hospitality, electronics, automobiles
|
Power, pharmaceuticals, utilities
|
Return
|
High return in an expanding economy
|
Consistent return across all phases of economic expansion
|
Risk
|
High risk because of how the recession affects them
|
Lower risk in comparison to cyclical stocks
|
Conclusion
Cyclical equities provide opportunities to profit as the economy grows. However, they also carry risks. As an informed investor, you should look long-term and be prepared to deal with ups and downs. Diversify your investments to ensure safety.
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