Cyclical stock and Non-Cyclical Stock
Cyclical stocks are those that move in the direction of the market. It has a direct relationship to the economy. When the economy is doing well, the stocks go up and when the economy goes down, the value of the stock goes down as well. Companies whose stocks are cyclical tend to be more prone to various economic fluctuations.
Automobile companies are a classic example of cyclical stock. When the economy is going well, people buy automobiles. Because everybody is earning. There is an increase in the sale of automobiles. Hence the shares of automobile companies have high demand. Construction and travel are also examples of cyclical stocks. They are not essential items. They are often referred to as offensive stock.
Cyclical stocks are not steady earners. They keep fluctuating according to the economic conditions.
Non-cyclic stocks repeatedly outperform the market when the market goes down. This type of stocks do well in both good and bad economic conditions. They are not linked to the economy. The demand for products and services in this category continues regardless of the economy.
These are essential goods and services without which people and businesses can’t survive. Utilities, food producers, pharmaceuticals examples of non-cyclic stocks. The demand for these goods remains the same irrespective of the market condition, unlike cyclical stock. It is also referred to as defensive stocks because they can defend investors against the effects of an economic downturn.
For example, non-durable household goods like toothpaste, soap, shampoo, and dish detergent may not seem like essentials, but they really can’t be sacrificed. Most people don’t feel they can wait until next year to lather up with soap in the shower.
There are various measures and indicators which determine the type of stock. The three most important are:
- Systemic risk is one of the indicators which is used to determine whether a stock is cyclical or non-cyclical. It measures the volatility of stocks compared to that of the market. Systemic risk index greater than one indicates the stock is highly volatile.
- Earnings per Share (EPS) is a market ratio that reflects how much profit a company’s share earns. Usually, cyclical stocks tend to have more volatile EPS since they are more closely correlated to market fluctuations.
- Price to Earnings Ratio (P/E) measures the comparison between the price of a stock and its earnings. The value for the cyclical stocks is usually lower than the one of non-cyclical stocks.
Cyclical stock provides a higher return than non-cyclical stocks. However, the investor should study the market conditions carefully and have a good tolerance for risk. Non-cyclic stock is safer investments but provide lower returns.