In this article, we will discuss
- How Cyclical Stocks Work
- Pros and Cons of Cyclical Stocks
- Difference Between Cyclical Stocks and Non-Cyclical Stocks
- When Should One Invest in Cyclical Stocks?
- Cyclical Stocks Taxation
- Final Words
Cyclical stocks are stocks heavily affected by fluctuations in the business cycle. Companies that issue such stocks generally enjoy high demand for their products and services when the economy is at a boom. This increases the share price of these businesses during periods of economic growth.
However, when the business cycle is going through a downturn, the demand for these stocks declines among investors. As these companies experience low-profit margins or losses, their share prices fall as well.
To know more about cyclical shares, their benefits and limitations, keep reading this article.
How Cyclical Stocks Work
As per the cyclical stock definition, these stocks tend to do well when the economy is growing but perform poorly during economic downturns.
For example, when the economy is doing well, people tend to buy more electronic gadgets because they have extra money to spend. However, during economic downturns, demand for these gadgets tends to drop as people postpone big purchases due to financial concerns.
Companies that rely on the economic cycle for their earnings are called cyclical companies. This includes car manufacturers, luxury brands, airlines, furniture sellers, hotels, restaurants, banks and insurance companies. Stocks of these companies perform well in bull markets because consumers have enough disposable income to spend on their products and services.
Investing in cyclical stocks can lead to substantial returns if you can accurately predict economic cycles. However, it's crucial to be aware that cyclical stocks come with higher risks compared to non-cyclical stocks, as they are more sensitive to economic changes.
Pros and Cons of Cyclical Stocks
Now that you know what is cyclical stocks, it is important for you to understand their benefits and limitations. Below we have discussed the pros and cons in detail.
- Easy to Identify Stocks: It is easy to identify cyclical stocks due to their involvement in seasoned businesses of service and goods industries. Moreover, if you notice any luxury brand, it is possible you are identifying a cyclical share.
- High Returns: The best cyclical stocks in the market are the high-return products. This is because the business cycle takes the prices of stock either up or low. For cyclical stocks, the investors buy them at a low price and sell them when the price is high, thus expecting high returns from the same.
- Predictable: Investing in stocks involves prediction and intuition alongside research. Cyclical stocks follow patterns that make it easy for investors to time their entry and exit points. All they have to do is buy shares at the low point and sell when prices are high.
- Profits Are Uncertain: The competition among companies in the market is very high due to technological advancements. Hence the profits become uncertain due to the demand and competition being high.
- Risks Are High: Cyclical stocks are high risk in nature as they work according to the business cycle and go through several fluctuations. Their returns are low or negative during recessions and an investment can turn worthless if the company goes bankrupt.
Difference Between Cyclical Stocks and Non-Cyclical Stocks
To get an idea about Cyclical vs. Non Cyclical Stocks, check the table given below.
The risk on cyclical stocks is very high.
The risk factor is low for non-cyclical stocks.
Cyclical sectors list comprises companies that produce consumer utility products.
Non-cyclical stock focuses on sectors like pharmaceuticals, defence and others.
The returns are high mainly during the upward trend of the business cycle.
The performance is stable overall.
When Should One Invest in Cyclical Stocks?
After you understand the meaning of cyclical stocks, it is important to analyse the perfect time to invest in one. Timing is crucial, as investing during a recession can lead to significant gains when the economy rebounds. For those seeking capital gains, it's essential to be aware of business cycle fluctuations.
Investors looking for regular dividends should buy cyclical stocks during the recovery phase when sales and profits are on the rise. Analysing current business cycle trends, and expected returns, and considering risk factors are important for maximising gains during market fluctuations.
Cyclical Stocks Taxation
Cyclical stocks are taxed just like any other stock. Investors are liable to pay capital gains tax when they sell their shares at a profit. Additionally, they might get dividends that are taxed as per an investor’s income tax slab.
However, when you buy and sell cyclical stocks can affect the tax outcomes. This is mainly because gains or losses within a year might be balanced out by gains or losses in another year. Keep in mind that this situation depends entirely on your overall tax situation.
Overall, cyclical stocks move in sync with the prevailing market trends. Their prices rise when the economy flourishes but can easily fall during a recession. So before thinking of purchasing cycling stocks, make sure to have an idea of the current business cycle to avoid losses.
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Frequently Asked Questions
Q1. What are some examples of cyclical stocks?
Ans.Some examples of cyclical stocks include Eicher Motors Ltd, TVS Motor Company Ltd, City Union Bank Ltd, ICICI Bank Ltd, NBCC (India) Ltd, Shree Cement Ltd, HEG Ltd, etc.
Q2. Is cyclical stock and business cycle interdependent?
Ans. Yes, cyclical stocks and the business cycle are interdependent. The performance of cyclical stocks is tightly linked to business cycle stages, altering returns based on economic conditions.
Q3. Are bank stocks cyclical in nature?
Ans. For quite some time, the banking sector was cyclical. But recently they have converted into defensive stocks, having close competition with the private sector banks.
Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING.
The asset classes and securities quoted in the film are exemplary and are not recommendatory.
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