Difference between Cyclical and Non Cyclical Stocks

Cyclical Stocks

Cyclical stocks mainly comprise of the businesses that perform well during the time of economic expansions when the consumer spending is also high. Some of the major examples of cyclical stocks are automakers, home construction, fast moving consumer goods, apparel makers, etc. In times of an economic upswing, these businesses manage to take advantage of the tendencies of consumers to spend higher than usual. People are more willing to allocate more money towards non-essential goods. But at times of economic contractions the consumers are forced to reduce their spending on such products and only focus on buying essential goods and services. These financial instruments are correlated with the business cycles and there are four key phases which any investor must know about if they are planning to invest in cyclical stocks:

  • Expansion – In this phase the economic activity is on the rise which leads to increased access for consumers to products and services.
  • Peak – It refers to the highest point in the economic activity that follows an economic expansion and comes before recession.
  • Recession – An economic recession refers to a decline in the economic activity in the market.
  • Recovery – It is a period when the economic activity starts to reverse directions and slowly trudge back from recession.

Non Cyclical Stocks

The non cyclical stocks (also known as defensive stocks) comprise businesses that mainly operate in industries that perform well regardless of the overall economics situation. These businesses are into offering essential goods like food, water, electricity, gas, household products, etc. During times when the confidence within the economy is low, with chances of loss in employment or reduced salaries, consumers focus their spending only on essential goods and services. This leads to increased share prices of non-cyclical stocks and reduction in market value of cyclical stocks.

The businesses that are in the non-cyclical industries have a sticky demand. It means that the demand for their product or service will be there regardless of the state of the economy. The stocks of these companies tend to offer a much safer dividend for their investors at all times. They also offer a stable growth in terms of the market value of the stock which also makes them hugely popular.

Difference between Cyclical and Non Cyclical Stocks

Both cyclical and non cyclical stocks have their advantages for investors. With the right kind of investment strategy, the stockholders can make good money from these financial instruments in the long run. However, it is important to note that there are some major points of difference between cyclical and non cyclical stocks and we must discuss them below to get a deeper insight into this topic:

Cyclical Stock

Non Cyclical Stock

Definition

A cyclical stock belongs to businesses that do extremely well during times of economic expansions but suffer a heavy downturn during recessions.

A non cyclical stock belongs to businesses that perform well regardless of the state of the economy.

Type of goods

The businesses with cyclical stocks mainly offer non essential or luxury goods.

The businesses with non cyclical stocks mainly offer essential goods.

Correlation

The cyclical stocks are positively correlated with the economic conditions in which they operate.

The non cyclical stocks are not at all correlated with the economic conditions in which they operate.

Volatility

The cyclical stocks are mostly very volatile in terms of their market value because they depend heavily on the economic conditions. They are also known as offensive stocks.

The non cyclical stocks are not very volatile in terms of their market value because they do not depend on the economic conditions. They are also known as defensive stocks.

Diversification

The cyclical stocks come from businesses across a wide variety of industrial sectors.

The non cyclical stocks come from businesses that are mostly concentrated within a few industrial sectors.

Risk and return

The cyclical stocks carry a high risk during times of adverse economic conditions but they also lead to higher returns when the conditions improve.

The non cyclical stocks carry a low to moderate amount of risk and return because their performance is stable across all economic conditions.

Conclusion

Both cyclical and non cyclical stocks have several differentiating factors. They have specific benefits, but they also have pitfalls that the investors need to be aware of. With the right investment strategy, both cyclical and non cyclical stockholders can stand to gain better returns from the market in the long run.

Frequently Asked Questions

What are the major pros and cons of cyclical stocks?

The major pros of cyclical stocks are as follows:

  • They are fairly easy to read and understand.
  • They can offer much higher returns compared to non cyclical stocks during an economic boom.
  • There is a wider scope of diversification because these stocks are spread across a wide array of sectors.

The cons of cyclical stocks are as follows:

  • They are extremely volatile when compared to non cyclical stocks.
  • Their returns can come down swifty when compared to non cyclical stocks during an economic downturn.
  • Investors putting their money in cyclical stocks need to have a sound knowledge about the share market.

What are the main pros and cons of non cyclical stocks?

The major pros of cyclical stocks are as follows:

  • They can offer a much stable growth rate compared to cyclical stocks.
  • They also tend to offer a much more consistent rate of dividend.
  • These stocks are relatively less volatile compared to cyclical stocks.

The cons of non cyclical stocks are as follows:

  • There is a narrower scope of diversification because these stocks are spread across a wide array of sectors.
  • Their returns are not as high compared to cyclical stocks during times of economic prosperity.
  • There is a potential for loss in non cyclical stocks as well although it is much smaller when compared to cyclical stocks

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