Some investors believe that value stocks are cyclical and that they will eventually experience a downturn. Others believe the current market conditions present a buying opportunity for these stocks. So, are value stocks cyclical? Read on to find out.
What Are Value Stocks?
Value stocks trade at a price well below their intrinsic value or the price they would be worth owning.
These stocks can allow investors to buy into quality companies while paying much less than they’re worth.
Although there is no guaranteed way to identify value stocks that will outperform in any given market environment, investors looking for value stocks typically consider factors such as price-to-earnings ratios and price-to-book valuations.
Therefore, investors should only focus on buying value stocks with a well-researched investment strategy they’re willing to stick with through good times and bad.
What Are Cyclical Stocks?
Cyclical stocks tend to fluctuate in value along with the business cycle.
This means they tend to experience periods of high volatility, followed by periods of low volatility.
For example, when the economy is strong and growing, cyclical companies deliver good earnings results, and their share prices go up.
However, as growth begins to slow down and the economy enters into a period of contraction or recession, these companies may face more challenging conditions, and their share prices will tend to decline.
The main drivers behind cyclical stocks are changes in consumer confidence and spending levels, which can be influenced by various factors.
Some factors include employment levels, interest rates, inflation, exchange rates, and housing market conditions.
In addition to these economic factors, cyclical companies may also experience shifts in demand driven by changes in consumer behavior or technological developments within the industry.
Are Value Stocks Cyclical?
Yes, the idea of value stocks being cyclical has attracted quite a bit of attention from investors, with many analysts believing that the concept is well supported by historical data.
These stocks are essential in a market cycle because they offer an investment opportunity outside traditional growth stocks.
During economic expansions, cyclical companies benefit from increased demand for their products and services, which drives profit margins and stock prices.
However, during recessions, these same businesses are negatively impacted as consumers cut back on spending.
As a result, value stocks tend to underperform during these periods.
Examples of Cyclical Stocks
Examples of cyclical stocks include automakers, airlines, hotels, restaurants, and clothing stores.
These companies typically have periodic highs and lows in terms of revenue and profit based on seasonal factors or general economic conditions.
Several factors influence the value of cyclical stocks, including general economic conditions and consumer confidence.
For example, when consumers have more money to spend at restaurants, the demand for goods increases. This can lead to higher profits for these businesses, leading to higher stock prices.
However, this can also be reversed if consumers are experiencing financial hardships or recessionary periods that decrease spending habits.
The same logic applies to automakers and airlines, as changes in fuel costs or other inputs can affect revenue and profit over time.
What Are the Non-cyclical Stocks?
Non-cyclical stocks, also called defensive stocks, provide products or services that people will always need, such as food, water, utilities, and gasoline.
People cannot go without these necessities, so demand for them tends to be more stable over time.
These companies tend to have less dramatic price swings than cyclical stocks and often protect against inflation to some extent.
Many investors consider consumer staples stocks to be relatively safe bets during an economic downturn because people will continue to buy these items regardless.
Examples of Non-cyclical Stocks
Procter & Gamble is a consumer staples company that produces soap and other household products like laundry detergent and shampoo.
Though the stock market may fluctuate, people will still need soap to do their laundry every week, so demand for these products tends to remain pretty consistent.
Another category of non-cyclical stock is healthcare.
This sector includes companies that manufacture pharmaceuticals and medical devices, which people also need all the time, regardless of economic conditions.
The healthcare industry as a whole benefits from periods of economic downturns because more people tend to seek out healthcare services when they are out of work.
Companies that manufacture and sell medical devices like Band-Aids, crutches, and cough syrup tend to also be stable investments during periods of economic growth or contraction.
The key to successful value investing is understanding the economic cycles of the market.
Value stocks are cyclical, meaning they will go through periods of outperforming and underperforming the market.
During an economic recovery, value stocks rebound strongly as investor confidence returns and corporate profits grow.
For long-term investors, owning a mix of value and growth stocks could be the best way to maximize returns while minimizing risk.
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