What is a 'Cyclical Stock'
A cyclical stock is an equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies that sell discretionary items consumers can afford to buy more of in a booming economy and cut back on during a recession. Contrast cyclical stocks with consumer staples, which people continue to demand even during a downturn.
BREAKING DOWN 'Cyclical Stock'Cyclical stocks rise and fall with the business cycle. This seeming predictability in the movement of these stock's prices leads some investors to attempt to time the market by buying these stocks at the low point in the business cycle and selling them at the high point. Examples of companies whose stocks are cyclical include car manufacturers, airlines, furniture retailers, clothing stores, hotels and restaurants. When the economy is doing well, people can afford to buy new cars, upgrade their home furnishings, go shopping and travel. When the economy is doing poorly, these discretionary expenses are some of the first things consumers cut. If a recession is bad enough, cyclical stocks can become completely worthless as companies go out of business.
Examples of Consumer Cyclical Stocks
The category of consumer cyclical stocks can be further divided into durables, non-durables and services.
Durable goods companies are involved in the manufacture or distribution of physical goods that have an expected lifespan of more than three years. Companies that operate in this segment include automakers such as Ford Motor Company, appliance manufacturers such as Whirlpool Corporation and furniture makers such as Ethan Allen Interiors Inc. The measure of durable goods orders is a strong indicator of future economic performance. When durable goods orders are up in a particular month, it may be an indication of stronger economic activity in the ensuing months.
Non-durable goods companies produce or distribute soft goods that have an expected lifespan of less than three years. Examples of companies operating in this segment are sports apparel manufacturer Nike Inc. and retail stores such as Nordstrom Inc. and Target Inc.
Services is a separate category of cyclical stocks, because these companies don't manufacture or distribute physical goods. Instead, they provide services that facilitate travel, entertainment and other leisure activities for consumers. Walt Disney Company is one of the best-known companies operating in this space, but it is joined by many companies operating in the new digital space of streaming media, such as Netflix Inc. and Time Warner Inc.
The Role of Cyclical Stocks in a Portfolio
Cyclical stocks are viewed as more volatile than non-cyclical or defensive stocks, which tend to be more stable during periods of economic weakness. However, they offer greater potential for growth, as they tend to outperform the market during periods of economic strength. Investors seeking long-term growth with reduced volatility tend to balance their portfolios with a mix of cyclical stocks and non-cyclical stocks.