By Aniket Bose. Edited by Arjun Chandrasekar.
A cyclical stock is a stock whose underlying business usually follows the economic cycle of expansion and recession. Cyclical businesses best perform through economic expansions but typically profits fall significantly during natural recessions and other difficult economic periods. Cyclical stocks and their companies have a direct relationship with the economy; these stocks represent companies that make or sell discretionary items and services that are high in demand when the economy is in a good state, and when people have more money to spend. The four sectors that make up a large portion of cyclical stocks are Basic Materials, Consumer Cyclical, Financial Services, and Real Estate. The consumer cyclical sector is one of the larger sectors in the overall stock market. Investors find it difficult to invest in cyclical stocks because of their correlation to the economy; since it is hard to predict the ups and downs of the economic cycle, it is very tricky for investors to know how well a cyclical stock will do. Cyclical stocks most commonly include hotel chains, restaurants, furniture, airlines, cruise lines, designer clothes, and automobile manufacturers.
A non-cyclical stock is stocks that represent products and services that consumers and businesses can’t live without; these businesses support the essential factors of life for all people, which make them immune to most economic cycles. Suppose the economy takes a sudden hit and starts to decrease rapidly. People will have to cut down on spending in unnecessary areas, but still need to have the essentials to survive on a daily basis. An example of a non-cyclical stock is toothpaste or soap. These stocks repeatedly outperform the stock market when the economic growth in other sectors starts to slow down. Non-cyclical stocks are more profitable than cyclical stocks in the long run because regardless of the economic change, people will always have a large demand for essential products. Companies that have non-cyclical stocks that produce these goods and services are also referred to as “defensive stocks” because they can defend investors against the rapid downturn of the economy during a period of recession. The perfect time to invest in non-cyclical stocks is when the economic outlook is sour because the price will be low but the demand for essentials remains high. One issue with non-cyclical stocks, however, is that they won’t skyrocket in price when other sectors of the economy tend to grow rapidly. For investors, investing in non-cyclical stocks is a great investment strategy to avoid losses when highly cyclical companies are suffering, and remain financially sound for the long run.
Overall, the key difference between cyclical and non-cyclical stocks lies in the economic cycle and consumer needs/wants. Cyclical stocks follow the economic cycle, and profit massively during expansions, but decline during recessions and downturns. Non-cyclical stocks profit during recessions and economic downturns but do not have the same level of growth during periods of economic prosperity.
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