---
title: "What is a Cyclical Business?"
description: "What is a cyclical business? When and why does it make sense to buy stock in a cyclical companies?"
canonical_url: https://trendshare.org/how-to-invest/what-is-a-cyclical-business
markdown_url: https://trendshare.org/ai/what-is-a-cyclical-business.md
published: 2014-09-20
last_updated: 2017-12-31
content_license: https://trendshare.org/about/disclaimer
---
# What is a Cyclical Business?

Source: https://trendshare.org/how-to-invest/what-is-a-cyclical-business
Updated: 2017-12-31
Some businesses make money by selling a lot of products to a lot of people.
Others make money selling a few very expensive products to a few customers.
Businesses are divided into [stock sectors](/stocks/list_sectors)
and [stock industries](/stocks/list_industries); this allows
investors and analysts to compare similar business types.

Before you invest in any business, you need to understand the business cycle
which governs sales and investments. How does the company stay in business?
What's its relationship to competitors? (What's its [economic moat](https://trendshare.org/how-to-invest/what-is-an-economic-moat-for-a-stock)?)

One type of business worth understanding is a cyclical business.

## What is a Cyclical Stock? What is a Cyclical Business?

A *cyclical business* is an enterprise in which revenue ebbs and
flows based on a [predictable business cycle](http://www.colorado.edu/economics/courses/econ2020/section7/section7-main.html). A *cyclical stock* is the stock of such a
business.

The canonical example of a cyclical stock is an auto manufacturer such as [Ford](/stocks/F/view) or [GM](/stocks/GM/view). Think about
how cars are sold. Every model year, the manufacturer comes out with a new
version, probably a slight upgrade over the previous edition. The previous
year's cars are sold at a discount, because who wants to buy a new 2017 car
when the 2018 model has just come out?

Ford's problem is that incremental yearly upgrades aren't free. You can get
by with tweaking the way you build engines and frames and put things together a
little bit, but after four or five or six or seven years, you'll have to retool
the entire factory, and that costs millions and millions of dollars.

Every few years, Ford (and Chrysler and GM and Toyota and...) must invest
billions of dollars in new and upgraded factories just to stay in business.  If
the business plans well and sets aside money every year, this isn't a bad thing
(it's a normal cost of being in this particular industry, and it helps weed out
competitors who can't match this cycle over the long term). Yet it also affects
the quarterly numbers reported every three months. As capital expenses go up,
profits go down and analysts rate the stock lower.

Hold that thought.

## Why Do Stock Prices Fluctuate on Cycles?

Whenever you see a cycle in the stock market, assume that the market as a
whole will move with that cycle. To paraphrase Warren Buffett, be cautious when
others are exuberant and buy (good stocks) when others are pessimistic. This
does suggest that *counter cyclical stocks* exist; when the economy in
general is faltering, they soar. Sometimes your best strategy is to make
*countercyclical* investments—trade against the direction of the
cycle.

When [Ford](/stocks/F/view) spends a cool billion dollars on a
new factory and reports that it won't record any profits this year, people tend
to sell the stock and depress its price. Sometimes it goes below the [intrinsic value](https://trendshare.org/how-to-invest/what-is-intrinsic-value) of the company. (The market
can get really pessimistic if you look at it quarter by quarter.)

If [GM](/stocks/GM/view) announces that it's deliberately
investing in the business to make more money next year, the year after, and the
year after that, but as a consequence [it won't pay dividends](https://trendshare.org/how-to-invest/why-do-some-companies-not-pay-dividends) for a
while (example made up), you'll probably see a dip in its price. It's almost as
if pension funds and money markets and target date funds can't bear to show any
quarterly losses, and so they shuffle their money around and churn stocks,
trying to stay just ahead of these business cycles that you can predict in
certain stock sectors.

Even if the board of directors of the company and its upper management have
a good plan and a track record of successful decisions like this one, lots of
parts of the market have no taste for long term planning. The incentive
structures of funds and investment management companies and, yes, [broker fees](https://trendshare.org/how-to-invest/broker-fees) reward this short term thinking.

## How to Make Money From Cyclical Stocks

Knowing the psychology of the market makes it a little easier to predict,
but performing reliable [discounted cash flow](https://trendshare.org/how-to-invest/what-is-discounted-cash-flow) calculations on a stock with [fluctuating free cash](https://trendshare.org/how-to-invest/what-is-free-cash-flow-jitter) or owner
earnings adds risk to your analysis. This makes a simple value investing [buy and hold](https://trendshare.org/how-to-invest/buy-and-hold) strategy more difficult.

At the same time, knowing that cyclical businesses have cyclical stock
prices (periods of undervalued prices followed by periods of overvalued
prices), you *can* buy when prices seem low and sell when prices seem
high. This requires even more diligence and patience, and it requires even more
self control than the "buy and hold forever" strategy.

To make a countercyclical analysis work, you must look into the stock's
historical trends. How often does the company reinvest profit into operating
expenses or take out loans? How long do they take to pay off? How does the
market react?

It's easy to see when a stock price slides (financial indicators such as [book value](https://trendshare.org/how-to-invest/what-is-the-book-value-of-a-stock) or [debt and asset ratios](https://trendshare.org/how-to-invest/debt-and-assets) help answer the questions "Is
it undervalued?" or "How undervalued is it?"). You *can't* answer
beforehand the question "What's the lowest this stock price will go?" If you're
trying to time the market to get the absolute best price, give up now. You'll
beat yourself up psychologically trying to chase every last percentage point of
profit.

Predicting the high point of the stock is difficult too. There's no
guarantee that the stock will ever reach an overvalued point before the next
cycle of factory building begins. (That's the *hope* of the business's
management, of course. Invest a lot one year to reap profits in subsequent
years. Hope and reality are not always the same thing.)

To make money from a cyclical company, buy low and sell high and set
yourself an acceptable profit threshold. (15% per year? 30% overall? Whatever
makes sense.) When—*if*—the stock heats up, start selling.
You may not reap your maximum potential profit, but if you're greedy, you'll
find yourself paralyzed and losing out on great opportunities because you're
scared to miss out on the best possible opportunity.

## How Cyclical Businesses Manage Their Finances

Auto manufacturers and airlines aren't the only businesses which have cycles
of investment. [Intel](/stocks/INTC/view) is a good example of how
to manage manufacturing cycles well and still provide consistent profits.  [Intel's manufacturing and research and development follow a tick/tock strategy](http://www.intel.com/content/www/us/en/silicon-innovations/intel-tick-tock-model-general.html). The
first version of a new semiconductor (the "tick") offers something new: a
smaller size, a faster clock speed, a new manufacturing process. It's mostly
research, and the product is for early adopter customers who can afford to pay
a premium for a new product.

The "tock" strategy is the next part of the cycle. It's a refinement of the
new product. It's cheaper to make. It has better yields. It's a little cheaper,
so they can sell to hundreds or thousands more times the customers.

Granted, Intel has a huge advantage over its competitors. Its size and cash
reserves make it easy to invest in several fabs at once, refining the process.
As well, the varying needs of computer chips in all sorts of devices make it
possible to sell older chips for devices which need less power than the hot new
smartphone.

In short, having multiple simultaneous product lines, each on its own cycle,
moderates the annual hit to the business of investing all profits into one big
factory every few years. Yet not every business dominates its industry as Intel
does. Not every business is as large as Intel. Even so, Intel's strategy is no
accident.

## Should You Invest in Cyclical Businesses?

Does it make sense to pursue a countercyclical strategy? That depends on
your appetite for investing risk, your investment plans, and the way you think
about your stocks. If you're comfortable watching an investment for low points
and high points to buy low and sell high, you can find good profits over the
course of several years. If, on the other hand, you prefer simplicity
investments, looking for a cyclical company such as Intel which manages its
business cycle without prolonged periods of booms and busts may give you a
chance to buy low and hold for a long time.

Ultimately it's not the cyclical nature of the business which provides the
potential for profit. It's the fact that sometimes the market undervalues [the long term ability of the business to generate earnings](https://trendshare.org/how-to-invest/earnings-matter-most) for its owners. You can often see this most dramatically in
cyclical businesses, but it's present in all market sectors and industries. You
can find it if you look.