Just so you know, investing is all about offense and defense, just like in a war or sports. It’s very difficult to become a successful investor with just one method. And cyclical and non-cyclical stocks should be part of your arsenal.
This article will focus all about on cyclical and non-cyclical stocks.
The Big Picture
The idea behind cyclical and non-cyclical stocks is simple. When money is tight, what can you do without or put off, and what do you actually need?
You may want a new car, but if your budget is so tight, it may have to wait. However, toothpaste, toilet paper, and electricity can’t wait.
Cyclical stocks represent those items and services for consumers and businesses they buy when confidence in the economy is high. Non-cyclical stocks represent those items and services for consumers and businesses that they can’t put off no matter what the state of the economy.
Here are some more on cyclical and non-cyclical stocks.
A cyclical stock is an equity security whose price is affected by the ups and downs in the overall economy. Cyclical stocks typically pertain to companies that sell flexible items consumers can afford to buy more of in a growing economy and cut back on during a slump. Contrast cyclical stocks with consumer staples, which people continue to demand even during an economic downturn.
Cyclical stocks rise and fall with the business cycle. This apparent predictability in the movement of these stock’s prices leads some investors to attempt to time the market. They buy the stocks at the low point in the business cycle and sell them at the high point. Examples of companies whose stocks are cyclical include car manufacturers, airlines, furniture retailers, clothing stores, hotels and restaurants. When the economy is doing well, people can afford to buy new cars, upgrade their homes, shop and travel. When the economy is doing poorly, these flexible expenses are some of the first things consumers cut. If a recession is bad enough, cyclical stocks can become completely worthless as companies go out of business.
Example of Cyclical Stocks
Durable goods companies are involved in the manufacture or distribution of physical goods that have a lifespan of more than three years. Companies that operate in this segment include automakers, appliance manufacturers, and furniture makers.
The measure of durable goods orders is an indicator of future economic performance. When durable goods orders are up in a particular month, it may indicate stronger economic activity in the ensuing months.
Non-durable goods companies produce or distribute soft goods that have an expected lifespan of fewer than three years. Examples of companies operating in this segment are sports apparel manufacturers and retail stores.
Services are a separate category of cyclical stocks because these companies don’t manufacture or distribute physical goods. Instead, they provide services that facilitate travel, entertainment and other leisure activities for consumers. Walt Disney Company is one of the best-known companies operating in this space, but it is joined by many companies operating in the new digital space of streaming media.
Cyclical Stocks in a Portfolio
Cyclical stocks are more volatile than non-cyclical stocks, which tend to be more stable during periods of economic weakness. However, they offer greater potential for growth because they tend to outperform the market during periods of economic strength. Investors seeking long-term growth with reduced volatility tend to balance their portfolios with a mix of both of those stocks.
A non-cyclical stock or defensive stock provides a constant dividend and stable earnings regardless of the state of stock market. Because of the constant demand for their products, they usually remain stable during the various phases of the business cycle. A defensive stock should not be confused with a “defense stock,” which refers to stock in companies that manufacture things like weapons, ammunition and fighter jets.
During recessions, non-cyclical stocks tend to perform better than the market. However, during an expansion phase, they tend to perform below the market. This is attributed to their low beta as defensive stocks typically have betas of less than one.
Example of Non-cyclical Stocks
The utility industry is an example of defensive stocks because, during all phases of the business cycle, people need gas and electricity. Investors tend to invest in defensive stocks if a market downturn is expected. However, if the market prospers, active investors will often choose stocks with higher betas to maximize their return.
Defensive stocks are characteristic of companies that produce or distribute consumer staples. Those are goods that people tend to buy out of necessity regardless of economic conditions. They include food, beverages, hygiene products, tobacco, medicines and certain household items. These companies generate steady cash flow and predictable earnings during strong and weak economies. As such, their stocks tend to outperform consumer cyclical stocks that sell flexible products during weak economies.
Non-cyclical Stocks in a Portfolio
Investors seeking to protect their portfolios during a weakening economy or periods of high volatility may increase their exposure to defensive stocks. Well-established companies such as Procter & Gamble Co., Johnson & Johnson, Phillip Morris International Inc. and Coca-Cola Co. are considered defensive stocks. In addition to strong cash flows, these companies have strong operations with the ability to weather weakening economic conditions. They also pay dividends, which can have the effect of cushioning the stock’s price during a market decline.
The difference between a cyclical stock and a non-cyclical stock is that a cyclical stock is highly correlated with movements of the business cycle, while a non-cyclical stock has little to no movement that correlates with the business cycle.
Cyclical stocks comprise businesses that operate in industries with high consumer spending during economic expansion. Non-cyclical stocks or defensive stocks comprise businesses that operate in industries that do well during economic downturns. This is because these businesses have essential goods such as utilities.
Best Cyclical Stocks for 2018
The force is still with Walt Disney. The “Star Wars” film franchise continues to pay off. “Rogue One” produced revenues well into 2017, and “Star Wars: The Last Jedi” was released late last year. Disney also sees massive revenue from its Marvel franchise movies. “Thor: Ragnarok” was released in November 2017, and “Black Panther” last month.
The public seems to be in the mood for entertainment and escape at theme parks, and the new Shanghai Disneyland Park should help boost theme park sales.
Genuine Parts Company
Genuine Parts has increased its dividend for 60 years. The company continues to prosper by acquiring other companies, and is now dominating the auto parts industry.
Genuine Parts’ business model and growth prospects make it a potential winner for 2018. Auto parts are in high demand and GPC is the go-to supplier. Revenues, gross profit and operating income have remained steady for four years. This stock is appealing to investors looking for dividends, safety and some possibility for growth. Shares of the company have been climbing steadily since late 2017.
General Motors Co.
It is hard to believe that General Motors was in danger of going out of business eight years ago. Last year, the company announced that it was investing 1 billion new dollars in manufacturing. The investments were intended to support 1,500 jobs. During the last four years, GM has created 25,000 new jobs.
Operating income has been flat for the past four quarters, and the dividend looks to be safe. In fact, the dividend has been growing, with an average yield of 2.66% over the past five years. America’s love affair with the car is far from over, and GM’s stock chart shows that investors are buying shares.
Best Non-Cyclical Stocks for 2018
Kraft Heinz Company
Kraft Heinz has been beating analyst expectations for earnings. The company sells well-known brands like Oscar Mayer, Heinz, Planters, Velveeta, Philadelphia, Lunchables, Maxwell House, Capri Sun, Ore-Ida, Kool-Aid, and Jell-O.
In 2017, KHC targeted cost cuts of $1.7 billion, focusing on efficiency to keep itself competitive in the packaged food business. It already sells in 31 countries, and it is not going away anytime soon.
Currently, the stock is recovering from a sharp drop in June 2017. It seems to have found support at around $75 per share, so investors will have to decide if this is a buying opportunity.
Johnson & Johnson
Johnson & Johnson covers a wide range of companies in the healthcare industry, giving it a diversity that should appeal to investors. Among its brands are Listerine, Neutrogena and Tylenol. Despite being a more defensive play, the stock managed to gain 20.6% in 2017 in a market that has rewarded growth far more than defensive stocks.
The company expects to boost sales by 4% to 5% over the next year and looks to benefit from both its investment to research and development and the impact of a weaker dollar.
Sysco is a food company that sells frozen foods, canned foods, dry foods and fresh meat, seafood and dairy. In other words, SYY is not going to run out of customers any time soon. The demand for its products will continue through the ups and downs of world economies, because these foods are not luxury items.
Sysco pays a dividend and offers some growth if the trend continues. The share price has been volatile since January of 2017.
See Also: Types of Stocks in the Market
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