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Investing in Cyclical Stocks v/s Non Cyclical Stocks 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
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. 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. |
