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How to Invest in Cyclical Stocks

The future of cyclical stocks looks bright, but it's important to pick companies from an industry that is due for a revival

Stock market volatility is a known thing. What is less known is the segment within the stock markets which moves in cycles of ups and downs. The famed investor Peter Lynch termed cyclicals as companies whose revenues and profits are in tandem with the state of the economy with their performance being tied to the business cycle.

Cyclicals, thus, suffer huge losses during recessions, often finding it hard to survive till the next boom. But, when things do start to change for the better, dramatic swings from losses to profits can often surpass expectations. It is to be noted that rise and fall in profit of cyclicals usually depends on various regulative and administrative policies.

Cyclicals have borne the brunt of a slowdown in the global economy and in India. Post the 2008 financial meltdown, cyclicals went out of favour as economic growth geared down into the slow lane. Order books stagnated quarter after quarter, buyers of capital goods companies for instance, did not take delivery of finished products and those that had already placed orders delayed or even cancelled previous orders.

The fortunes of cyclicals are bright with a clear election mandate which has given the BJP-led NDA a full majority. Over the next five years, one thing is certain that we will have a stable government at the centre. The economy may recover, but it is unlikely to happen overnight. While some of the parameters are already visible for the economy to gain and in turn for cyclical sectors and stocks to benefit.

Before selecting a cyclical stock, it makes sense to pick an industry that is due for a revival. For instance there are sectors sensitive to interest rates and then there are commodities that move in cycles. In this story we have identified eight stocks from four diverse cyclicals, which are the fittest sectors:

  1. Automobile
  2. Engineering
  3. Energy
  4. Metals and Mining

All the companies have quality business and operate with little or zero debt and all of them have made a name for themselves in their respective industries. As Lynch put it, cyclicals may be low-risk and high-gain or high-risk and low-gain, depending on how adept one is at anticipating business cycles. For investors, whether a turnaround happens fast or not, it is always better to stick with quality names-even in cyclicals.