Cyclical companies don’t fit with the Serious Investing Strategy recommended elsewhere on this blog since they are not long-term holdings. I therefore mainly cover them as something to avoid if you are following the strategy. For those who want to move in and out of the market, however, they may be worth consideration. Because capital gains will (hopefully) be realized when selling, holding these types of assets inside a tax sheltered account like an IRA instead of a fully taxable account would be a consideration since otherwise the tax bills will take a big bite out of your gains.
A cyclical company does well during good times, expanding and increasing production. During the bust that always follows, however, they then spend most of the profits they made closing down production and paying severance to workers. These are good stocks to hold during big expansions in the economy, but not good buys for long-term holdings since their stock price will be essentially flat over long periods of time.
Commodity companies, like oil and materials, producers have traditionally been cyclical companies. This makes sense since they ramp up production to supply the economy when other companies start using a lot of energy and materials to make their products. When other companies experience a slow down, they stop buying materials so the commodity producers need to scale back. The rapid expansion may also cause competitors to emerge, often flooding the market and causing the commodity price to collapse.
Companies that tend to be cyclical, besides material producers, include airlines, semiconductor companies, temporary agencies, automakers, and chemical companies. Airlines in particular always seem to operate on the brink of bankruptcy.
The easiest way to recognize a cyclical company is from its price history. It will see its price move up and down over a fairly wide range, but never really make any progress. Earnings are also an indicator. You’ll see a few year’s worth of positive, growing earnings followed by a period of declining earnings or even losses.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
