Cyclical stocks represent one of the different types of stocks that are categorized based on their alignment with a particular investment strategy. They specifically are shares of companies that are highly sensitive to the economic cycle. These companies tend to do well when the economy is expanding or during the boom phase of the cycle. However, during the bust phase or when the economy is in a recession, their value depreciates.
These stocks can be found in consumer discretionary and construction sectors and industries. Specific examples include producers of durable goods like cars, appliances, consumer electronics, clothing and apparel, furniture, and providers of non-essential services like hotels and airlines. Investing in cyclical stocks can be rewarding. They are also high-risk investments. This article lists the pros and cons of cyclical stocks.
Pros and Cons of Investing in Cyclical Stocks
Advantages of Cyclical Stocks
Investing in cyclical stocks can provide significant returns during times of economic expansion. Take note that these stocks also share some similarities with growth stocks. Investing in them is attuned with some of the principles of growth investing and value investing with the benefits of an invest-and-hold strategy, active portfolio management, or short-term trading. The following are the pros or advantages and benefits of investing in cyclical stocks:
• Portfolio Diversification: A diversified portfolio would include different types of stocks. Investing in cyclical stocks balances the overall performance of a portfolio composed of defensive stocks because it can help in spreading and reducing the impact of economic downturns on portfolio performance and investment returns.
• High Return Potential: One of the advantages of cyclical stocks is that they can provide their investors with higher returns during periods of economic expansion. Issuing companies tend to generate higher revenues and profitability which translate to stock appreciation and income-earning potential.
• Value Investing Potential: These stocks can also be considered value stocks in certain situations because they can be undervalued during a recession. Investing in them during an economic downturn means purchasing them at a discount for a higher potential for value appreciation when the economy recovers and rebounds.
• Passive Income Investment: Some cyclical stocks are also dividend stocks or preferred stocks which pay dividends by default or common stocks which may pay dividends during periods of high profitability. Examples include stocks issued by large companies in the consumer discretionary sector.
• Medium-Term Trading: There are different ways to earn from stocks. One of which is to trade rather than to invest and hold. Trading cyclical stocks means purchasing them during an economic downturn and selling them once the economy rebounds or if the value of these stocks appreciates.
Disadvantages of Cyclical Stocks
Stocks are ideal for aggressive investors because of the different risks and other disadvantages associated with stock investing. Cyclical stocks have higher risks than other types of stocks such as mid-cap stocks and large-cap stocks from providers of essential goods because investing in them depends on proper timing and awareness of the prevailing economic condition. The following are the specific cons or disadvantages of investing in cyclical stocks:
• Volatile and Unpredictable: One of the disadvantages of cyclical stocks is that they can be volatile and unpredictable. Their value or prices fluctuate in response to long-term economic conditions and even due to short-term hiccups in economic performance. Investors need to know the best time to purchase and sell these stocks.
• Requires Proper Timing: Timing is essential to maximizing the advantages of cyclical stocks. Investing in them would require a lot of skills and discipline because timing the stock market and predicting economic cycles are difficult due to different macroeconomic factors that can influence economic growth.
• Sector-Specific Risks Exposure: These stocks are also exposed to risks that are specific or unique to certain sectors and industries. Automakers and consumer electronics manufacturers or other non-essential producers are at risk of supply chain disruptions, evolving consumer preferences, or changes in the regulatory environment.
• Inconsistent Growth and Returns: Remember that the value of these stocks appreciates and depreciates in accordance with the boom-and-bust cycle of the economy. Growth and returns are inconsistent. A portfolio of these stocks can reflect losses during economic downturns and gains during economic expansion.