Demystified: Cyclical Stocks
After 5 long years, the S&P BSE Sensex touched an all-time high psychological level on 1 November. Despite the broader index touching a new crest, stock prices across the board don’t seem to share the same excitement. Why?
The reasons are diverse and can’t be reasoned out within one statement. For instance, realty, metal and capital goods indices are hovering at a much lower level than what it was in January 2008. The S&P BSE Realty index is down around 90% compared with the levels at the start of 2008. Why?
If you analyze these indices in detail, you can easily see, these businesses are cyclical in nature.
About Cyclical Stocks
A stock whose ups and downs are affected by an overall development in the economy is called a cyclical stock. These are the stocks that belong to companies which deal in sale of discretionary items – the items which are consumed in a far greater number by a consumer during booming economic conditions and experience reduction in usage when economy is performing badly.
Examples of companies with cyclical stocks include car manufacturers, hotels, clothing houses, furniture retail shops and others. These stocks rise and fall with the business cycle.
For instance, if economy of a country is performing well, real estate activity will see a rise. More and more number of housing units will be created by the builders, further giving rise to revenues and profits of construction and house selling companies. The rise in construction work will see cement makers also raking huge profits. The listed stocks will in turn see a rise in value. And, as the economy’s fiscal health deteriorates, same stocks will lose their worth. Companies in the commodities business see similar cycles as well. Even macro economic factors have a say in the rise and fall of such stocks.
However, there are some companies which are least affected by the changes in economic situation of a country. Particularly, FMCG companies rarely find reduction in profit with a macro or micro level slowdown as people rarely cut their expenditure on items such as soaps or toothpastes. Therefore, FMCG companies are not much hit by an economic slowdown. The S&P BSE FMCG index rose up by over 180% during the same period during which Sensex recovered after a long time and gained a record high.
However, if the recession is very bad, these cyclical stocks can turn out to be completely worthless, as the companies go out of business totally.