Sales and profits rise and fall in regular, if not completely regular fashion, as business expands and contracts.
Timing is everything. Coming out of a recession into a vigorous economy, they lourish more than Stalwarts. In the opposite direction, they can lose >50% very quickly and may take years before another upswing.
Most misunderstood type, and investors can lose money in stocks considered safe. Large Cyclicals are falsely classified as Stalwarts.
If a defensive Stalwart loses 50% in a slump, then Cyclicals may lose 80%.
It’s much easier to predict upswing, vs, a downturn, so one has to detect early signs of business changes. You get a working edge if you’re in the same industry – to be used to your advantage. Most important in Cyclicals.
Unreliable dividend payers. If they’ve financial problems, then they become potential Turnaround candidates.
Inventory build-up = bad sign. Inventory growth > Sales growth = red flag. Inventory build-up with companies having fluctuating end product pricing causes larger problems.
Monitor inventory to figure out business direction. If inventory is depleting in a depressed company, it’s the first evidence of a possible business turnaround.
High Operating Profit Margin (OPM) = Lowest Cost producer, who’s got a better chance of survival if business conditions deteriorate.
Upswing favours companies with Low OPM’s. Therefore, what you want to do is to Hold relatively High OPM companies for long term and play relatively Low OPM companies for successful Turnarounds / cycle turns.
The best time to get involved with Cyclicals is when the economy is at its weakest, earnings are at their lowest, and public sentiment is at its bleakest. Even though Cyclicals have rebounded in the same way 8 times since WWII, buying them in the early stages of an economic recovery is never easy. Every recession brings out sceptics who doubt that we will ever come out of it, who predict a depression and the country going bankrupt. If there’s any time not to own Cyclicals, it’s in a depression. “This one is different,” is the doomsayer’s litany, and, in fact, every recession is different, but that doesn’t mean it’s going to ruin us.
Whenever there was a recession, Lynch paid attention to them. Since he always thought positively and assumed that the economy will improve, he was willing to invest in Cyclicals at their nadir. Just when it seems it can’t get any worse, things begin to get better. A comeback of depressed Cyclicals with strong balance sheets is inevitable. Cyclicals lead the market higher at the end of a recession – how frequently today’s mountains turn into tomorrow’s molehills, and, vice versa.
Cyclicals are like blackjack: stay in the game too long and it’s bound to take back all your profits. Things can go from good to worse very quickly and it’s important to get out at the right time.
As business goes from lousy to mediocre, investors in Cyclicals can make money; as it goes from mediocre to good, they can make money; from good to excellent, they may make a little more money, though not as much as before. It’s when business goes from excellent back to good that investors begin to lose; from good to mediocre, they lose more; and from mediocre to lousy, they’re back where they started.
So, you have to know where we are in the cycle. But it’s not quite as simple as it sounds. Investing in Cyclicals has become a game of anticipation, making it doubly hard to make money. Large institutions try to get a jump on competitors by buying Cyclicals before they’ve shown any signs of recovery. This can lead to false starts, when stock prices run up and then fall back with each contradictory statistic (we’re recovering, we’re not recovering) that is released.
The principal danger is that you buy too early, then get discouraged, and, sell. To succeed, you’ve to have some way of tracking the fundamentals of the industry and the company. It’s perilous to invest without the working knowledge of the industry and its rhythms.
Timing the cycle is only half the battle. Other half is picking companies that will gain Most from an upturn. If Industry pick = Right, but Company pick = Wrong, then you can lose money just as easily as if you were wrong about the industry.
If investing in a troubled industry, buy companies with staying power. Also, wait for signs of revival. Some troubled industries never came back.
If you sell at 2x, you won’t get 10x. If the original story is intact or improving, stick around to see what happens and you’ll be amazed at the results.
Auto, airlines, steel, tyres, chemicals,
aerospace & defence, non-ferrous metals, nursing, lodging, oil & gas