Good and bad features of the Cyclical stocks

It’s quite difficult to choose any stock as an investment opportunity because of their amount, types and the whole list of factors which are necessary to be included. However, let’s analyse the cyclical stock – an asset which can be as profitable as non-profitable. It is crucial to understand the affecting aspects to acknowledge this type of asset in a more detailed and fulfilled way.

How to describe a сyclical stock

A stock which can be named cyclical is the one whose underlying project repeats the economic cycle of an upswing and a downswing. This pattern works like a clock: during economic upswing cyclical projects stay competitive and progressive whilst at the time of a downswing such businesses decline sales and capital gains both.

Current list of best cyclical stocks to buy

At the time of the huge economic growth which began in 2020, the world was waiting for a downswing due to the cycle pattern. The Federal Reserve began to raise interest rates to overwhelm inflation. Despite the expected downswing, the economy performed better and more flexibly. Currently, it is still moving within an upswing pattern, but the rise in interest rates still impacted on the cyclical stocks condition.

However, there are several stocks which can withstand this kind of influence because of a longer-term perspective. Here’s the list of these assets:

1. Walt Disney Company.
2. Airbnb.
3. EPR Properties.
4. Nucor.

Let’s analyse them individually.

Walt Disney Company

Disney entertainment company follows several cyclicality patterns. Consumers start to spend way less on discretionary purchases at the time of an economic downswing. Surely, this kind of behaviour impacts Disney’s list of services.

Despite those actions and the overall economical situation, Disney stays strong and still has a resilient enough demand for its services and products. The obvious example of such resilience is the economic intel of the fourth quarter of 2024. Basically, at the time consumers paid 1% more for the services, but Disney’s profit increased by 3%. Another addition to the services is Disney+ which is a streaming platform. It is growing the subscribers number every single day.

The company targets increased revenue in the next years. Right now, the strategy works and these cyclical stocks are worth attention.

Airbnb

Airbnb, currently, is a top-1 online vacation rental platform which has a strong resilience to an economic downswing. Its drastic growth in several years and the existing plan of increasing the momentum is very promising.

Airbnb targets the flexibility of the Amazon project: access to a huge list of travel opportunities and living needs. There are several plans of extension: building of new businesses, investing in projects which will improve the quality of services for a consumer and joining other widespread activities such as groceries and cleaning stores.

EPR Properties

EPR Properties is a strong real estate investment trust which targets the owning experiential real estate: movie theatres, ski resorts, food courts and e.t.c. It is also one the impact on businesses during the downswing, but in case of EPR Properties it withstands the pressure of such an economic recession. It is explained by the existing model of the EPR Properties investment trust.

This specific trust leases the properties to operating tenants under long-term triple net agreements. Such a business model will provide a company with a stable enough financial gain to withstand several economic downswings: with the continuous money flow which consists of monthly dividends. That’s why EPR Properties deserve the attention.

Nucor

Nucor is a Steel producer and it also is influenced by the economic downswing due to the steel’s dependance on the existing economic state. An upswing is followed by the increased use of steel within cars, buildings and other industrial good’s creation. Conversely, the demand for steel is declining at the time of economic downswing.

When the economy experiences another recession, Nucor withstands its pressure by gaining profits from the infrastructure spending increase. In comparison to others, Nucor is significantly stronger and way more resilient to the economic downswings.

For the past 52 years the company only increased its dividends which explains the deserved attention to this specific asset.

Investing strategies

First of all, take a look at the business cycle itself:

The downward movement of interest rates is a main aspect of the potential cyclical stock success. The existing connection between the cyclical stock and the economic state is as good as bad: during an upswing these shares are quite profitable and at the time of a downswing it performs quite badly.

Many market players are interested in companies with low price-to-earnings (P/E) multiples. But in the case of cyclical stock this may not be the best option. The overall earning fluctuations of these stocks is high enough to fit the P/E measurement. Low P/E multiples of cyclical stock mean undesirable investment. It is important to connect the economic state to the P/E multiples: high stands for a bottom of the cycle and low, conversely, means the high of the cycle.

However, such stocks can be observed much more precisely by price-to-book multiples. Valuations at a discount to the book value provides hopes for the future upswing. At the time of the existing upswing, such stocks valuation is significantly higher than the book value.

One of the key signs of the buying necessity is an insider buying. If owners and participants of the company buy these assets – it is a proof of the company’s full return to the upward movement.

And last, but not the least – company’s balance sheet. Resilience of the company also can be measured by its capital. The state of this balance can provide signals to market players who are interested in buying stocks at the deepest point of the downswing. If the balance of the observed company is high enough to provide confidence of the future growth – it can create a potential signal to buy these assets.

Cyclical sector’s instances

There are several things that are included in cyclical sectors:

1. Transportation. It is cyclical because of the direct connection between people travelling and the economy.
2. Consumer discretionary. It consists of luxury items, leisure activities and e.t.c.
3. Auto. Again, people follow the existing economic state and keep owning old cars with no desire to buy a new automobile at the time of the economic downswing.
4. Construction. It is another example of the reducing or increasing volumes due to a downturn and an upturn of the economy, respectively.

Instances

There are several instances of the existing cyclical stocks involvement:

1. Cyclical industries.
2. Non-сyclical industries.

Let’s analyze them individually.

Cyclical industries instances

There is a huge list of cyclical industries, too huge to observe at the moment. Let’s focus the attention on several ones:

1. Airlines. They have deep connections to the existing state of the economy.
2. Hotels. Same as airlines: strongly depends on the amount of spending money which is directly connected to the state of the economy.
3. Retail. It is worth mentioning that discretionary retail is also reducing at the time of the economic downswing. But retailers base their selling on the non-cyclical things.
4. Restaurants. It is also explained: people usually eat at home far more often during the downturns.
5. Automakers. The same principle of dependance: people decide to hold onto their old vehicles because of the economic downturn and it directly impacts on the stocks of automakers.
6. Technology. Almost every technological stock depends on the cycle. The price growth and weak resilience of the companies result in the reduction of buying.
7. Banks. It is one of the obvious connections: all auto loans, credit cards and e.t.c. will not be bought during a downturn. And, conversely, the capital gain of a company increases due to the falling of the interest rates.
8. Manufacturing. The overall money spending reduction directly influences the state of manufacturing profiting.

Consumer cyclicals can be: durable and non-durable. Durables ones are designed to endure a long-term perspective (Automobiles, for example). Non-durable ones exist for a shorter period of time (Fast food and clothing, for instance).

However, not every single economic downswing impacts on all cyclical stocks identically. It is necessary to remember during the analysis of the desired stocks.

Non-cyclical industries instances

There are several companies that aren’t involved in economic cycles. It is based on the type of business they executed. Stocks of such companies are named as defensive stocks or recession-proof investments. Their behaviour during both upswing and downswing is quite similar. Let’s take a look at several of them:

1. Non-discretionary retail. Resilient enough companies which always provide the necessary goods for the people.
2. Utilities stocks. These stocks withstand economic pressure because of the constant payments for electricity and water which people are obligated to execute. Such assets can be named defensive.
3. Real Estate. It can be as defensive as resilient: it depends on the nature of the company’s properties. Investment trusts which are considered to be more resilient: retail or medical office buildings outperform hotels at the time of economic downswing. Despite that there is some dependance on cycles which are connected to interest rates. Their falling will be a profit for a business and their rising will decrease the income, conversely.

Cyclical and defensive stocks examples

Let’s review the existing examples of both cyclical and defensive stocks to get the point. Firstly, cyclical:

1. JPMorgan Chase.
2. General Motors.
3. Boeing.
4. Texas Roadhouse.

Secondly, defensive:

1. Dominion Energy.
2. Costco.
3. Equity Residential.
4. General Mills.
5. Coca-Cola.

However, each of the enlisted stocks is not 100% cyclical or defensive: it all depends on the conditions of the existing downswing. But these assets still show general resilience to all changes within the market.

In addition, take a look at the consumer cyclical graph below.

Benefits

Let’s take a look at all beneficial sides of investing in cyclical stocks:

1. High potential for capital gains. At the time of the upswing, these assets can create a significant profit because of the direct connection between the demand and the stock’s behaviour. Buying such assets at the downswings can be very profitable due to the potential growth when the next upswing comes.
2. Market timing opportunities. The involvement of market indicators and business cycles is crucial to execute a perfectly timed deal. That’s why knowing these aspects directly impacts the possible income of the investor. Buying at the bottom of the downswing and selling the top of the upturn can be very profitable.
3. Dividend Yield. At the time of the economic enhancement, businesses often offered very profitable opportunities to market players. Such passive gains can protect the investor’s portfolio while waiting for substantial capital appreciation.
4. Portfolio diversification. Cyclical stocks, especially in a combination with defensive stocks, can diversify a portfolio. The overall balance between the reward between risk and reward can ensure the stability of the existing investment portfolio by increasing the continuous income.
5. Increased consumer spending patterns. Discretionary items will be highly demanded during the upswing: that’s why cyclical stocks are profiting hugely. Several sectors can gain a lot of income: luxury goods, travel and e.t.c.
6. Global exposure. The ability to provide services and goods throughout multinational markets also impacts on the stock’s state. The overall economic condition prevails the home market performance and such stocks can be very profitable during the upswing.

Drawbacks

Now let’s head out the disadvantages of this type of stocks:

1. Economic sensitivity. It is quite obvious that the downswing can hugely impact on the stock’s price. Such dependance can result in significant losses. Impatient investors can suffer from rash decisions.
2. Volatility. It is necessary to acknowledge that defensive stocks are less volatile than cyclical due to the connection between cyclical assets and the state of the economy. It means the unavoidable risk of losing the investment due to high inconsistency of the asset’s behaviour.
3. Timing the market is a complicated process. Perfect timing is very difficult to predict when it comes to cyclical stocks. A lot of market players suffered from inaccurate timings and lost their investments.
4. Longer time period of recovery. These assets can stand at lows for a significant amount of time. It obviously impacts on the investor and creates several doubts which can be a misguidance.
5. Dependance on consumer behaviour. All-in-All, this type of asset is in a great connection with the people’s involvement. Any decrease within an underlying industry can result in the price’s drop. It is crucial to analyse consumer trends to have a complete perspective on the possible asset’s fluctuations.
6. Influence of global events. These stocks are deeply connected to the existing world state: any financial cris, pandemic or a geopolitical conflict can easily impact on the stock’s behaviour.

Acknowledging all these aspects of the cyclical stocks will help you to make a better investment choice. It is crucial that such a money distribution model fits your own trading preferences.