cyclical vs. non-cyclical stocks: an overview
The terms cyclical and noncyclical refer to how closely a company’s share price is related to fluctuations in the economy. Cyclical stocks and their companies have a direct relationship to the economy, and noncyclical stocks repeatedly outperform the market when economic growth slows.
Investors cannot control the cycles of the economy, but they can adapt their investment practices to its trends and flows. Adapting to economic transitions requires understanding how industries relate to the economy. There are key distinctions between businesses that are vulnerable to broad economic changes and those that are essentially 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 downturn.
- Cyclical corporations sell goods and services that many buy when the economy is good but cut back on during a recession.
- Non-cyclical companies sell non-perishable household items such as soap and toothpaste.
Cyclical companies follow trends in the broader economy, making their share prices highly volatile. As the economy grows, cyclical stock prices will rise. As the economy declines, so do stock prices. They follow all the cycles of the economy, from boom, peak, and bust to recovery.
Cyclical stocks are companies that make or sell discretionary goods and services that are in demand when the economy is booming. They include restaurants, hotel chains, airlines, furniture, high-end clothing retailers, and automobile manufacturers. These are also the goods and services that people charge for first when times are tough.
When people delay or stop buying anything, the revenues of the companies that produce and sell it fall. This, in turn, puts pressure on their share prices, which begin to fall. In the event of a prolonged recession, some of these businesses may even go out of business.
- Cyclical industries make or produce products that we can live without or delay when times are tough. Examples of travel and construction
- Non-cyclical industries make or sell the basics that we continue to use even when money is tight. Utilities and soap are examples.
- Riders go up and down with the economy. Non-cyclical stocks are steady growers through thick and thin.
Investors may find it difficult to predict opportunities in cyclical stocks due to their correlation with the economy. Since the ups and downs of the business cycle are hard to predict, it’s hard to guess how well a cyclical stock will perform.
Noncyclical stocks repeatedly outperform the market when economic growth slows.
Non-cyclical stocks typically perform well regardless of economic trends because they produce or distribute goods and services that we always need, including food, power, water, and gas.
The shares of the companies that produce these goods and services are also called protected shares because they can protect investors from the effects of the economic downturn. They are excellent places to invest when the economic outlook is optimistic.
For example, essential household items like toothpaste, soap, shampoo, and dish detergent may not seem essential but may not actually be sacrificed. Most people don’t feel like they can wait until next year to put soap in the shower.
Another example of a non-cyclical company is a utility company. People need power and warmth for themselves and their families. By providing consistent usage services, utility companies grow conservatively and do not fluctuate significantly.
This is a key fact about acyclic stocks. They provide security, but their price will not skyrocket as 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, Ford Motor Co. (blue line), and a classic non-cyclical company, Florida Public Utilities Co. (red line). This chart clearly shows how each company’s stock price reacts to an economic downturn.