Cyclical Stocks

Each investor wants to predict the right price movements of stocks and when they will go up or fall. But, it is tough to predict the correct stock price movements as a host of factors affect it. Economic condition is one factor that significantly affects some stocks, known as cyclical stocks.

This article talks about what cyclical stocks are, examples of cyclical industries, the advantages of cyclical stocks, the difference between cyclical and non-cyclical stocks, and which is the best time to invest in cyclical shares.

What Are Cyclical Stocks?

Cyclical stocks are those whose performance depends on the overall economic conditions, i.e. whose prices rise in economic growth and drop in economic decline. As their performance follows various stages of the economic cycle, i.e. expansion, peak, contraction, and recovery, they are called cyclical stocks.

Understanding Cyclical Stocks

During various phases of the economic cycle, employment rates, interest rates, inflation rates, consumer spending patterns, etc., in the economy are likely to vary. 

For instance, the above-mentioned economic factors would be favourable during the expansion phase. People may enjoy increased income and like to spend them towards consumer discretionary items, i.e. those items which are not essential but desirable by consumers if they can afford them.

Therefore, companies engaged in such businesses may mark higher earnings, enabling them to provide greater stock returns in an expansionary period. The other way around may happen in the recessionary phase.

One of the salient features of cyclical stocks is higher beta. A stock’s beta reflects the stock volatility compared to benchmark indexes like NIFTY or SENSEX. Cyclical shares usually have a beta greater than 1, suggesting that such stocks are more volatile than the overall market.

Investors who don’t mind stomaching volatility to gain significant returns may like to invest in cyclical stocks.

Examples Of Cyclical Industries

Here are a few examples of cyclical industries, the stocks of companies in these industries may grow with economic growth and vice versa.

1. Aviation

Aviation, popularly known as the airline industry, is one of the cyclical industries. In the boom phase, more people with increased income may opt for airlines for traveling. However, people may avoid such expensive travel options in an unfavourable economic phase.
Eg: Interglobe Aviation Ltd, SpiceJet Ltd

2. Automobiles

The automobile industry is another cyclical sector in India because, in the economic downturn, people would delay purchasing a new vehicle if possible. However, they might buy vehicles instead of compromising on their requirements in favourable economic conditions due to potentially higher disposable income.
Eg: Bajaj Auto Limited, Maruti Suzuki India Limited

3. Banks and financial services

The banks and financial services, including businesses offering core banking, insurance, investments, etc., also see the impact of economic conditions. In a recession, the interest rates on various loans tend to fall, ultimately decreasing the earnings of such businesses. 

Plus, people may suffer from a financial crunch during that time, so the number of people failing to pay interest or loan amounts may increase. 

In contrast, they may see increased earnings due to more loan demands and investments in favourable economic conditions.
Eg: HDFC Bank Limited, Kotak Mahindra Bank, ICICI Bank, Bajaj finance

4. Information technology

Using the latest technologies and electronic devices is not the most essential for people to support their daily lives. They may spend on them when they can afford them but not prioritise such purchases when they can’t. Therefore, such businesses may enjoy higher earnings in economic growth and vice versa.
Eg: Infosys, TCS, TechM, HCL

Advantages of Cyclical Stocks

1. Massive growth potential

When the economy performs well, some businesses see higher demands and increased earnings, and cyclical stocks usually belong to those businesses. Therefore, cyclical stocks hold the potential to offer greater returns in times of economic growth. Such stocks may even outperform the overall market in favourable economic conditions and help investors to build wealth. 

2. Opportunity to buy at lower prices

If you turn to cyclical stocks in an economic downturn, you may find them trading at low-priced or undervalued due to lower demands. Buying cyclical shares at lower prices and keeping them till the economy rebounds may let you add more to your pockets. 

Difference Between Cyclical And Non-cyclical Stocks

Point of difference	Cyclical stocks	Non-cyclical stocks
Relation to the economy	Correlated with the economic conditions.	Usually less or unrelated to economic conditions
Volatility	More volatile	Less volatile
Risks and Returns	Higher risks, potentially higher returns	Lower risks, stable returns
Industries	Aviation, automobiles, banks and financial services, tourism, information technology, etc.	Utilities, consumer staples, and health care.

When To Invest In Cyclical Stocks?

Investing at the right time can make a vast difference in returns. Investing in cyclical stocks in an economic downturn may be beneficial if they are trading at lower prices than usual or their fair value. 

Such stocks may still be trading at a discount when the economy starts recovering. You may earn greater returns when they go up in favourable economic conditions.

Final Thoughts

Cyclical shares would offer greater returns in favourable economic conditions and vice versa. Investing in such stocks may provide you with greater returns but come with higher volatility. A mixture of cyclical and non-cyclical stocks may help investors balance the risks and returns during various economic phases.
You can invest in WealthBaskets using the platform of WealthDesk. WealthBaskets are the combinations of equities and ETFs, built by SEBI-registered professionals, and reflect an idea, theme, or strategy.

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