Cyclical vs. Non-Cyclical Stocks: An Overview
The terms cyclical and non-cyclical refer to how closely correlated a company's share price is to the fluctuations of the economy. Cyclical stocks and their companies have a direct relationship to the economy, while non-cyclical stocks repeatedly outperform the market when economic growth slows.
Investors cannot control the cycles of the economy, but they can tailor their investing practices to its ebb and flow. Adjusting to economic transitions requires an understanding of how industries relate to the economy. There are fundamental differences between companies that are affected by broad economic changes and those that are virtually immune to them.
- Cyclical stocks are volatile and tend to follow trends in the economy, while non-cyclical stocks outperform the market during an economic slowdown.
- Companies of cyclical stocks sell goods and services that many buy when the economy is doing well but cut during downturns.
- Non-cyclical companies sell goods household non-durable goods like soap and toothpaste.
Cyclical companies follow the trends in the overall economy, which makes their stock prices very volatile. When the economy grows, prices for cyclical stocks go up. When the economy turns down, their stock prices will drop. They follow all the cycles of the economy from expansion, peak, and recession all the way to recovery.
Cyclical stocks represent companies that make or sell discretionary items and services that are in demand when the economy is doing well. They include restaurants, hotel chains, airlines, furniture, high-end clothing retailers, and automobile manufacturers. These are also the goods and services that people cut first when times are tough.
When people delay or stop buying anything dispensable, the revenues of the companies that produce and sell them fall. This, in turn, puts pressure on their stock prices, which start to drop. In the event of a long downturn, some of these companies may even go out of business.
- Cyclical industries make or sell products that we can live without or delay buying when times are tough. Examples travel and construction.
- Non-cyclical industries make or sell the basics that we keep on using even when money is tight. Utilities and soap are examples.
- Cyclicals go up and down with the economy. Non-cyclical stocks are steady earners in good times and bad.
Investors may find opportunities in cyclical stocks hard to predict because of the correlation they have to the economy. Since it's hard to predict the ups and downs of the economic cycle, it's tricky to guess how well a cyclical stock will do.
Non-cyclical stocks repeatedly outperform the market when economic growth slows.
Non-cyclical securities are generally profitable regardless of economic trends because they produce or distribute goods and services we always need, including things like food, power, water, and gas.
The stocks of companies that produce these goods and services are also called defensive stocks because they can defend investors against the effects of economic downturn. They are great places in which to invest when the economic outlook is sour.
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.
A utility company is another example of a non-cyclical. People need power and heat for themselves and their families. By providing a service that is consistently used, utility companies grow conservatively and do not fluctuate dramatically.
This is a key fact about non-cyclical stocks. They provide safety, but they are not going to skyrocket in price when the economy grows.
Investing in non-cyclical stocks is a good way to avoid losses when highly cyclical companies are suffering.
Below is a chart showing the performance of a highly cyclical company, the Ford Motor Co. (blue line), and a classic non-cyclical company, Florida Public Utilities Co. (red line). This chart clearly demonstrates how each company's share price reacts to downturns in the economy.
Notice that the downturn in the economy from 2000 to 2002 drastically reduced Ford's share price, whereas the growth of Florida Public Utilities' share price barely blinked at the slowdown.