What is a Cyclical Stock?

Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is “Cyclical Stock”.

A Cyclical stock is a stock highly correlated to the economic activity. When the economy is in a recession the profits of a cyclical company tend to drop and so its share price. Conversely, when the economy is in a good shape the share price tends to goes up with the profit growth. The best example is the automobile sector. Indeed an individual is not willing to buy a new car when his income lowers, which drags car manufacturers’ revenues down.
On the contrary, he will be more tempted to treat himself with a new car if his economic situation is improving. Another example would be IT firms. A company is more reluctant to invest in renewing its computer system if it is in the middle of an economic turmoil and facing a declining activity. This expenditure will certainly be postponed until the recovery.
Since cyclical stocks generally rise in good economic times and fall during bad times, investors attracted to cyclical stocks are faced with the arduous task of trying to time the market. This means they must try to predict where the bottom of the business cycle is in order to buy these stocks at the optimal time and then predict where the top of the cycle is in order to sell at the optimal time.
Regardless, timing the market can be hard, given the fact that some cyclical stocks start bouncing back before a recession is actually over. Holding the stock of companies in cyclical industries over the long-term is therefore a somewhat controversial issue because economic downturns can take years to recover from.

By Barry Norman, Investors Trading Academy