Cyclical VS Non-Cyclical Stocks: What Sets Them Apart

Cyclical VS Non-Cyclical Stocks: What Sets Them Apart

Being an investor, stocks are probably one of the most prominent parts of your investing experience. You should also know that there are different types of stocks that you can invest in. Two of these are the cyclical and non-cyclical stocks.

Cyclical and non-cyclical stocks are opposites of each other. Companies that fall under these categories offer different products that answer different wants and needs of every consumer.

There are times when it will be advisable for you to buy either stock. But before you do that, let’s help you decide which one will be the best investment for you.

Cyclical vs Non-Cyclical Stocks Infographic

What is a Cyclical Stock

A cyclical stock is inclusive of the stocks that tend to fluctuate along with the overall business cycle. Prices of stocks that belong in this group are affected by the slight differences in the economy as a whole.

These kinds of stocks are usually related to companies selling items that are affordable for consumers in a booming economy. But once a recession takes place, the consumers will be able to cut back without suffering too much loss. These are items that mostly fall on the “wants” category and not the “needs”.

Discretionary expenses are normally the first ones to go when the economy ends up doing poorly. This is because in an economy with good performance, people can afford spending money for themselves. Ergo, consumers can buy new cars, renovate their homes, shop, and travel when the economy is performing well.

But when the economy goes through a recession, items offered by these companies start being neglected. This causes the stocks of the companies to devaluate.

Due to the seemingly predictable market trends, some investors usually attempt to time the market. They will then proceed to buying stocks at the low point in the business cycle and sell them at the high point.

Timing is a really important factor of investing in cyclical stocks. You have to time the right moment for you to sell your shares or you can end up stuck in a prolonged recession.

Cyclical stocks depends highly on the economy’s performance, they’re seen as more volatile than its counterpart, non-cyclical or defensive stocks. Despite this, they offer greater potential for growth during periods of economic strength. So you should be on the look-out to buy cyclical stocks when the economy begins pulling out of a recession.

Advantages and Disadvantages of Investing in Cyclical Stocks

Advantages:

  • Cyclical stocks have bigger exposure to movements in the wider market. The market has numerous sectors, and even more companies that offer stocks in that vast market.
  • You can ride the wave of economic growth to its highest peak. Cyclical stocks give more profits during times when the economy is rising. The more money the consumers have, the more they can spend on discretionary items and services. This means that value of the company’s stocks will also rise, giving way to greater profits.
  • Buying cyclical stocks early during a market rebound can produce strong returns for the investor. You can easily stay ahead of the economic conditions and be able to anticipate the growth in GDP by following relevant indices and financial indicators.

Disadvantages:

  • High volatility due to dependence on the business cycle.
  • Even small changes in the economy can highly affect the stocks of the company.
  • Despite the rise in stock prices, it does not necessarily indicate stronger consumer purchasing power.

Examples of Cyclical Stocks

Companies that have cyclical stocks include those in car manufacturing, airlines, furniture retail, clothing stores, hotels, and restaurants. It can also be further divided into three categories: durables, non-durables, and services.

Durable Goods: Companies involved in manufacturing and/or distributing physical goods that can last for more than three years. If the orders for durable goods are up during a particular month, it can act as an indicator of stronger economic activity ahead.

  • Ford Motor Company
  • Whirlpool Corporation
  • Ethan Allen Interiors Inc.

Non-durable Goods: Companies that produce and/or distribute soft goods that have expected lifespan of less than three years.

  • Nike Inc.
  • Nordstrom Inc.
  • Target Inc.

Services: Companies that provide services for travel, entertainment, and other leisure activities. It belongs to an entirely separate category since they don’t necessarily have to produce or manufacture physical goods.

  • Walt Disney Company
  • Netflix Inc.
  • Time Warner Inc.

Charts with stacks of gold coins and buy-sell dice

What is a Non-Cyclical Stock

Non-Cyclical stocks are also known as defensive stocks. These stocks will still provide constant dividend and stable earnings regardless of the state the overall stock market is in. This is mostly because of the demand for their products.

Defensive or non-cyclical stocks tend to remain stable no matter what state the economy might be in. They mostly outperform the market during recession but the opposite happens during expansion phase.

It’s always considered a good time to buy non-cyclical stocks, no matter the economy’s state. But the best time to buy non-cyclical stocks is when the economy is about to go to a downturn. This is mainly the reason why investors call it defensive stocks.

Owning non-cyclical stocks can work as a safety net that investors can fallback into during turbulent times.

Companies under this category are those that are always sought out by the consumers. People mostly flock to buy the products of these companies out of necessity, no matter if the budget is tight. This makes it harder for the company’s stocks to devaluate.

But steadiness is not always a good thing since it can also prevent the stock value from going up. You can obtain steady profit but don’t expect that it will rise immediately.

Advantages and Disadvantages of Investing in Non-Cyclical Stocks

Advantages:

  • You can easily depend of defensive stocks during recessions. Defensive stocks do not take too much damage even on declining market. This is because of the high dividends that usually act as support to the stock price. It therefore experiences less dramatic falls than other stocks’ prices in the market.
  • Profitability of non-cyclical stock will still be sustained even during economic times. This means that even when money is tight, consumers’ demand will remain unchanged.

Disadvantages:

  • Defensive stocks tend to be sensitive when it comes to rising interest rates. With the rise of interest rates, investments like corporate bonds and U.S. Treasury securities, will gain more attention from investors.
  • Rising interest rates can also affect the company’s ability to continue paying dividends. If the company has to pay more interest rates, this may affect the company’s earnings.
  • They are also less likely to go up in value since they are steady in nature. So, if you’re looking into making a healthy profit on the stock market, this makes choosing defensive stocks harder.

Examples of Non-Cyclical Stocks

There are two classifications that companies belonging in the defensive stocks can go into.

The first classification will be food, beverage, and utility companies.

  • The Procter & Gamble Company
  • The Coca-Cola Company
  • Unilever NV
  • PepsiCo

The second classification is the companies that produce non-durable goods. These include household goods like soap, detergent, toothpaste and other food items.

  • Kimberly-Clark Corporation
  • Colgate-Palmolive Company
  • Church & Dwight Company, Inc.

What’s the difference?

The only thing that sets cyclical stocks apart from non-cyclical stocks is the mere difference between luxury and necessity.

An investor can invest in both cyclical and non-cyclical stocks at the same time. This makes it possible for you to own a portfolio that is smoothed out for the entire business cycle.

Also, as was previously discussed, the cyclical stocks are highly correlated with the movements of the business cycle. Non-cyclical or defensive stocks, on the other hand, are the opposite. No matter the movement of the business cycle, value of non-cyclical stocks will have little to no change at all.

The two types of stocks have various sub-classes that will further divide the companies. This will make classification of a sector a little more difficult than you might think. You will have to observe the company’s behavior. You also have to track any changes that company might make which can in turn change their status from cyclical to a non-cyclical sub-class or vice versa.

Stocks rise and fall figures and tables

Conclusion

Depending on the situation that the economy and the overall market might be in, it’ll be great to invest in cyclical stocks. On the other hand, non-cyclical or defensive stocks will be a good investment any time. But you should still consider various factors that can affect either of them before making a final decision.

There are advantages and disadvantages that can help you decide whether that stock is the right one for you. Factors like the amount of time you can invest as well as the capital can also help in making the decision for you.

Also, find out what classification the company you’re interested in belongs to. Knowing this can help you adjust your expectations regarding the stocks and the profit you stand to gain. Aside from that, you will also be able to find out which stock will match your current financial standing.

You wouldn’t have to do anything but read and type some to find out sufficient information about the company you want to invest in, thanks to the internet.

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