What Are Cyclical and Non-Cyclical Stocks?

Cyclical stocks are equities of companies whose underlying businesses ebb and flow with economic cycles of expansion and recession. Such cyclical businesses typically outperform during times of economic upturn and prosperity. Conversely, they generally see significant declines in revenues and profits during economic downturns. 

Business activity in cyclical industries reflects the strength of the overall economy. When market conditions are unfavourable, consumers postpone or cut their spending for products or services in cyclical sectors. As a result, share prices of cyclical stocks typically reflect the level of business activity.

In addition to the general industry classification, several other indicators help investors identify individual cyclical stocks. 

– Beta: One of the most common is the beta value of a stock, which measures its volatility of returns relative to the entire market. 

A higher beta value implies higher volatility of the share price. Cyclical stocks typically have high beta values, often more than 1. For instance, if the beta value is 1.6, the stock is 60% more volatile than the broader market. 

– EPS: Another indicator is the earnings per share (EPS), calculated as a company’s net income divided by the total number of its outstanding shares. The resulting number serves as an indicator of a company’s profitability. Cyclical stocks tend to have a volatile EPS, as they heavily rely on business cycles. 

– Price to earnings (P/E) ratio: In addition, the P/E ratio is usually lower for cyclical stocks due to the fluctuations in both their stock price and EPS. Note that when investors look for companies with low P/E multiples, they should also pay attention to the industry. Earnings of cyclical stocks tend to fluctuate considerably to make P/E a meaningful measure by itself. Therefore, investors need to research a given equity in depth.

Cyclical stocks are mostly companies that sell discretionary items that consumers and businesses can afford to buy without hesitation during an economic boom. When the economy is strong, consumers can spend their income without fear for the future as they feel their jobs are secure. But, on the other hand, they will hesitate to spend money on all non-essentials when the economy is struggling. 

Understandably, there could be overlaps between sectors. For instance, a luxury name could also be classified as an automaker or a retailer. Examples of cyclical stocks from cyclical industries include:

Automobile and related businesses: According to the US Federal Trade Commission (FTC), “a new car is second only to a home as the most expensive purchase” for most Americans, and this will be similar in the U.K. Yet, the very same consumers can immediately put off such financial decisions amid economic uncertainties.

Aston Martin Lagonda Global Holdings (AML), and TI Fluid Systems (TIFS) are examples in this sector.

Banking: Most bank stocks are cyclical. Their profitability often drops during a recession when the demand for banking instruments declines, and many consumers struggle to pay off their debts. 

Lloyds Banking Group (LLOY) and Wells Fargo (NYSE:WFC), as well as smaller banks, such as Virgin Money UK (VMUK) or TBC Bank Group (TBCG), are examples of cyclical bank stocks that are relatively recession-prone but poised to perform well during prosperous times. 

Chip (or Semiconductor): These companies design and manufacture chips with a relatively short lifespan. 

Alphawave IP Group (AWE) and IQE (IQE) are among the businesses that are impacted by the highly cyclical nature of the semiconductor industry.

Commercial real estate: Similar to the overall economy, commercial real estate is cyclical. 

Examples of commercial real estate stocks are Segro (SGRO), Land Securities (LAND) and British Land Company (BLND).

Construction: The construction sector, which heavily relies on home buying and renovation trends, is directly impacted by economic cycles.

Related companies include Balfour Beatty (BALF), Morgan Sindall (MGNS), and Galliford Try (GFRD).

Luxury goods: Luxury goods makers typically have well-known brands and enjoy high operating margins. Yet, when an economy contracts and enters a recessionary cycle, discretionary spending on luxury items typically suffers from a slowdown in spending. 

Burberry (BRBY) and Watches of Switzerland (WOSG) are among luxury stocks.

Media and entertainment: Digitalization has helped broaden the scope of this sector as it now includes social media, streaming, eSports and iGaming stocks as well.

Several well-known stocks in the segment include WPP (WPP), Informa (INF), Pearson (PSON) and ITV (ITV).

Mining: A few cyclical stocks are inversely-correlated with the course of the economy. Considered a safe-haven investment, the price of gold and other precious metals tends to rise amid economic recessions. 

BHP Group (BHP), Rio Tinto (RIO), Anglo American  (AAL) and Glencore (GLEN) are among the cyclical mining companies.

Retail: This segment includes brick-and-mortar stores as well as eCommerce names. Economic cycles, such as recessions, can bring significant shifts in consumer behaviour, affecting how businesses adapt. For instance, when the economy contracts, ​​off-price or discount stores are likely to do better.

Among the most prominent retail stocks are Next (NXT), JD Sports Fashion (JD), Kingfisher (KGF), WH Smith (SMWH) and Deliveroo (ROO).

Travel and leisure (such as airlines, hotels, or restaurants): During times of prosperity, travel stocks generate higher revenues since consumers can spare extra budget on non-essentials like travel. Conversely, people are less willing to spend money on travel in times of financial hardship. 

International Consolidated Airlines (ICAG), EasyJet (EZJ), and Wizz Air (WIZZ) are among the top cyclical airlines stocks.

Examples of leisure stocks such as hotels and restaurants include Intercontinental Hotels (IHG), Compass Group (CPG), and Mitchells and Butlers (MAB).

Textile and apparel: Returns of shares of clothing and textile companies are also dependent on the strength of the economy.

Joules Group (JOUL), Ted Baker (TED), and Quiz (QUIZ) are among the names in this segment.

Non-cyclical stocks are equities of companies whose underlying businesses are not disrupted by economic cycles. These companies offer products and services that meet consumers’ basic needs like food, power, water, and gas. 

As a result, economic cycles have little to no bearing on the price movement of these stocks. Such non-cyclical stocks are also regarded as defensive stocks because they can help defend portfolios against an economic downturn. 

Defensive stocks are in sectors like utilities, food, health care, and consumer staples. Many have historically generated solid returns and dividends. Examples include:

– Food & Beverages: Companies providing daily essentials like food and beverages make reliable defensive stocks. 

For example, Associated British Foods (ABF) and Tate & Lyle (TATE) have managed to increase their revenue streams during times of contraction.

– Health Care: People do not refrain from paying for health care products, especially when they’re sick. 

Examples include AstraZeneca (AZN), GSK (GSK), and Hikma (HIK).

– Residential REITs: Individuals always need shelter, and housing is a basic need. Therefore residential REITs could be considered non-cyclical stocks. 

Segro (SGRO), Shaftesbury (SHB), and Great Portland Estates (GPEG) fit into this category.

– Utilities: This segment makes a great example for non-cyclical stocks. Even during the recession, consumers (for the most part) pay their bills for power and water. 

United Utilities (UU) and Severn Trent (SVT) are among the non-cyclical utility stocks. 

Knowing the differences and distinctions between cyclical and non-cyclical stocks is key to creating a balanced portfolio.

•   Strong performers during periods of economic growth

•   Associated with goods or services consumers tend to spend more money on during expansionary periods

•   Highly sensitive to shifting economic cycles

•   Earnings fluctuate during the economic cycle

•   More volatile in terms of stock returns

•   Typically lose value when the economy contracts, but fare better in times of economic expansion

•   Many cyclical stocks are not dividend payers

•   Better performers during periods of economic contraction

•   Associated with goods or services that consumers consider essential

•   Less sensitive to changing economic environments

•   Earnings are relatively stable 

•   Are less volatile in terms of stock returns

•   Typically hold up well during periods of economic contraction

•   Most non-cyclical stocks pay dividends

Given these differences, having a mix of cyclical and non-cyclical stocks in a long-term portfolio can be an appropriate hedging strategy. Owning cyclical stocks during expansionary periods can lead to massive returns. Yet, amid economic downtrends, investors holding non-cyclical stocks can pursue more of a buy-and-forget strategy thanks to their defensive nature.