Most stocks are affected in some way by economic factors, but cyclical stocks typically experience dramatic increases or decreases as a result of movement in the economy. The prices of cyclical stocks soar when the economy performs well and dramatically fall when the economy performs poorly. In contrast, the prices of non-cyclical stocks, also called defensive stocks, are not determined by changes in the economy. Investors should understand the features of cyclical and non-cyclical stocks to determine the best time to buy and sell stocks.
Features of Cyclical Stocks
Cyclical stocks are typically issued by companies that produce luxury items. In a time of economic growth, employment is usually high, which leads to an increase in consumer spending. Consumers buy more luxury items when the economy is performing well. The automotive industry is an example of a cyclical industry. During times of economic growth, consumers are more apt to spend money on a new car. Automotive makers begin to experience an increase in revenue, which typically leads to an increase in profits and stock prices.
Buying Cyclical Stocks
Knowing the right time to buy and sell is an important aspect of investing in cyclical stocks. The earnings performance of a cyclical stock is erratic at times, so failing to buy or sell at the right time can result in a drastic loss in profit. According to an article on Money-Zine.com, a good time for investors to purchase cyclical stocks is when the economy is recovering from a recession. As the economy improves, consumers who held on to their money during a recession are likely to spend it on items they desire.
Features of Non-Cyclical Stocks
Companies that issue non-cyclical stocks produce consumer goods that most people need regardless of the health of the economy. When an economy is experiencing a recession, companies of non-cyclical stocks experience small changes in revenue because consumers still need non-cyclical items for everyday living. Also, companies do not experience an increase in sales when the economy comes out of a recession. For example, people do not buy less toothpaste in a bad economy or buy more toothpaste during a good economy. Other examples of non-cyclical stocks include utilities, non-durable goods and food and beverage.
Buying Non-Cyclical Stocks
In most cases, it is never a bad time to invest in cyclical stocks. A non-cyclical stock that is undervalued continues to experience growth regardless of how the economy performs. Non-cyclical stocks do not perform as well as cyclical stocks when the economy is recovering, and therefore provide below-average returns in a good economy. Many investors choose to buy non-cyclical stocks when an economy is entering a recession or when the stock market is experiencing long-term volatility.
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