You as an investor cannot change
the economic conditions of the market nor its behaviour.
However it is important for you to learn the differences
between cyclical stocks and non cyclical stocks and their
relationship with the performance of the economy.
Cyclical
& Non Cyclical Stocks Defined
Cyclical and non cyclical is the
correlation of stocks with the economic conditions of
the market and general fluctuations of the economy. Cyclical
stocks are highly correlated with the market conditions.
For example, if the economy is weak and consumers are
not spending money, Cyclical stocks will experience a
decline in prices. This is because with less disposable
income, consumers can afford less luxuries and material
goods. This results in lower sales and net income results
for Cyclical stock companies.
On the other hand, non Cyclical stocks
are also known as Defensive stocks because they do NOT
rely on consumer spending. Companies with non Cyclical
stocks offer essential products such as food, water, power
and gas that everyone needs every single day. No matter
how the economy performs, all consumers will need to eat
today. Therefore, non Cyclical stocks are not subject
to economic conditions.
Therefore, the difference between
Cyclical and non Cyclical stocks is the difference between
luxury spending and necessities shopping. For example,
if the economy is not strong and people do not have a
lot of disposable income left over, they will cut back
on their luxuries spending and buy the necessities. For
example, a person will not buy a brand new PC today if
he does not have enough money to buy food for the month.
When economic conditions are good,
people will be more likely to go out to eat at expensive
restaurants (cyclical stocks) versus if the economy is
poor and people suffice their meals with bread and butter
(non Cyclical stocks).
Examples
of Cyclical Industries
-
Steel
- Construction
- Travel
- Electronics
- Armani & Versace Brand Names
Examples of Non
Cyclical Industries
a) Utilities
Non Cyclical stocks can be best illustrated
with utility companies. No matter how the economy is performing,
most families would like to have heat and power in their
homes. We need heat & power to cook food, wash our clothes,
etc. These are basic necessities. Likewise, utility companies
are not subject to economic fluctuations.
If there is an economic downturn, investors
prefer investing in utility companies because they provide
a steady return on investment without much risk.
Note: When the economy starts to explode in terms of growth,
utility stocks will NOT also skyrocket. They will be pretty
much stable and no great returns will be experienced.
b) Tobacco
Tobacco companies are considered non
Cyclical because it is hard for people to quit smoking,
even if they are tight on money. For smokers, smoking is
like the 3 essential meals of the day. Therefore, no matter
how the economy performs, tobacco companies produce relatively
conservative returns on investment and are stable.
c) Household Non-Durable Goods
Items such as toothpaste, soap and
Windex are essential for our health and the health of our
homes. Therefore even in times of economic recession, people
will not cut back on essential items such as these. Therefore,
these items are considered to be in the non Cyclical industries.
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