Cyclical and non-cyclical companies in the international securities market
Investors cannot control the cycles of the economy, but they can and should adjust their methods and investment strategies to its ups and downs. Tailoring strategies to the economic situation requires an understanding of how different industries relate to general trends in the economy.
It is important for an investor to know the fundamental difference between cyclical and non-cyclical companies so that he can distinguish between sectors that are affected by economic changes and those that are no longer vulnerable.
This will help you invest more profitably during an economic downturn.
The meaning of the concept of a cyclic and non-cyclic company
These terms refer to how the price of a companys stock is correlated with economic fluctuations. Non-cyclical stocks outperform the market significantly when economic growth slows down, while cyclical companies are highly correlated to the economy.
Non-cyclical securities, also called safety stocks, are profitable regardless of economic circulations because these companies produce or distribute goods and services that are always needed: food, energy, water and gas.
The sales volumes of cyclical companies, on the other hand, depend on whether the economy is strong.
Sales will flourish when people have extra income to spend on luxuries, and they will decline when the economy plummets.
The difference between cyclical and non-cyclical industries is simply the difference between need and luxury. There are certain industries that we cannot live without and will not cut spending on them, even when times are not very good.
For example, perishable products, things that are quickly used in household use, such as: toothpaste, soap, shampoo, etc.
They dont seem very important, but few would be willing to go without them for too long. Most people are unlikely to wait until next year to wash with soap in the shower.
Another example is the hotel business. Hotel chains located in the largest cities of Europe and America do not suffer from a lack of customers at any time of the year and during any economic disasters. For example, in St. Petersburg, such hotels include Sokos Olympic Garden. This hotel belongs to the famous Finnish chain Sokos.
The stocks of companies that make these things are non-cyclical and "protected" against the effects of an economic downturn, providing greater security for capital investment even when the economic outlook is unfavorable.
Contrast that with the new car youve got your eye on. While its more fun to buy a new car than a soap, youre more likely to put off buying a car for a year or two if your finances feel the effects of a slump.
Another good example of a cyclical industry is expensive restaurants. When the economy is booming and incomes are growing - these properties flourish and their shares increase in value, when there is an economic downturn - people are more likely to save money and eat at home or in cheap restaurants.
Other examples of cyclical industries are manufacturing - steel, travel and construction - sectors that produce things that can be done without in times of trouble.
Non-cyclical industries are a relatively safe haven for investment capital in turbulent times.
Lets take a closer look at non-cyclical industry options, as this can be important when a downturn is on the horizon.
The so-called utilities companies (sewage, water and power) are an excellent example of a non-cyclical industry. Such companies can help investors avoid losses when highly cyclical companies suffer.
For example, by selling shares of Caterpillar and buying back shares of, say, Minnesota Power Inc. the investor is executing a maneuver similar to which investors have used for years during economic downturns.
If times get tough, there isnt much money for construction projects, and thus construction companies may be less likely to buy heavy equipment.
But, regardless of the economic situation, people need heat and energy. Thus, utility companies are more conservative both in times of recession and during economic growth - their stock prices are much less prone to fluctuations.
Another example from another industry is cheap hotels located in major cities. For example, an inexpensive Hostel in St. Petersburg will always be in demand due to the influx of foreign and Russian tourists who traveled and travel to the Northern Capital both on business and in order to get acquainted with the sights of this wonderful city. Therefore, hotels and chains of hotels in a large number of cases can be classified as non-cyclical companies.
Daily household items
As mentioned, people will always need certain household items. From deodorant to bleach, there are things a person cannot do without even in times of economic downturn.
So companies like Procter & Gamble, Colgate-Palmolive, and Gillette Co. are very attractive for investment, especially when the economy is in a protracted peak.
Its easy to see why tobacco companies are considered non-cyclical: Its hard for smokers to stop smoking, even during an economic downturn.
Thus, a company like British American Tobacco should be showing good stability in difficult times for the economy.
Even though tobacco production is considered a "sin" industry and may be unethical for some investors, it does have the characteristics of a non-cyclical sector.
Companies providing legal services are also classified as non-cyclical. There is a crisis, there is no crisis - the demand for legal services is constantly high. Moreover, in times of crisis, it can even increase.
Methods for predicting economic downturns and upswings are beyond the scope of this article. But, simply understanding that different industries react differently to economic fluctuations can help an investor save money. As the economy cools, cyclical stock prices plunge and investors have to find a safer place to put their money. And the best refuge is the stocks of companies whose products cannot be dispensed with at any time.
Your questions and comments: