A Complete Guide on Cyclical Stocks

There are economic cycles of expansion and contraction that reflect the period of prosperity and recession. Many sectors and companies have high exposure to the broad economic cycles and their share prices fluctuate as per the different business cycles. Such stocks are known as cyclical stocks. Let us understand cyclical stocks meaning and their benefits.

What are Cyclical Stocks?

Cyclical stocks are those stocks that are easily affected by fluctuations in the business cycle. Companies that issue such stocks tend to enjoy a high demand for the products they offer during an economic boom. As a result, the prices of their shares also increase. On the other hand, whenever there is a downturn in the business cycle, the demand for such products reduces. Thus, there is a significant drop in the prices of their shares.

Examples of cyclical stocks may include shares of luxury goods manufacturers, automobile companies, airlines and hotels. These shares can be termed cyclical stocks because such companies witness a rise in sales of their products and services when the economy is booming, while they feel pain when the economy slows down.

What are the Benefits of Investing in Cyclical Shares?

If you choose to invest in cyclical shares, you can enjoy the following benefits:

High Returns:

Since the performance of the economy strongly influences how cyclical stocks react, the expansion and peak phases of the economic and business cycles have an effect on these stocks. For instance, during these phases, underlying companies tend to generate significant returns on investments. Thus, if you have invested in these stocks, you can enjoy extensive wealth creation as and when the prices of shares appreciate during periods of strong economic growth.

Easy Identification:

Another advantage of wanting to invest in cyclical stocks is that you can easily spot them in the stock market. Cyclical stocks are primarily associated with goods and services that are classified as comfort or luxury. These products and services are not crucial for survival but are catered towards individuals who have a higher disposable income. You can easily locate such products on the market and purchase stocks of the same to earn gains from the changes in the business cycle.

Predictability:

The fluctuations in the business cycle are considered to be a systematic risk. You can easily spot these fluctuations also by keeping track of the growth rate of the nation’s Gross Domestic Product (GDP). Plus, you can do so even if you are not well-versed in the inner working of the stock market. You can use basic knowledge and analytic skills to keep up with the business cycle and purchase corresponding shares to earn returns whenever possible.

What are the Limitations of Investing in Cyclical Stocks?

Despite the many advantages, there are certain pitfalls to investing in cyclical stocks. They are as follows:

High Risk:

Since the price of cyclical stocks is associated with fluctuations in the business cycle, drastic alterations in the latter can have an equally dramatic effect on the former.

Uncertain Profits:

Although the prices of cyclical stocks are connected to changes in the business and economic cycles, sometimes share prices may see a drop even during times of economic boom. This is because the demand for these goods and services also depends on customer wants and the competition in the market.

Ideally, cyclical stocks are more suited for investors who have a grasp on market fluctuations and want to invest for a longer period of time. You also need to have a strong risk appetite to invest in cyclical stocks. However, investors must research and make sure to invest as per their financial needs and risk profile.

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