What are cyclical stocks?
The building blocks of stock market are individual stocks so cyclical nature of stock market is inherently generated from cyclical movements of individual stocks. So what is a cyclical stock? In simple words, stocks which follow the economic cycle i.e. grows in price rapidly with expanding economy and falls with the same speed when economy is contracting are called cyclical stocks.
Let"s add one more angle to this generic definition as we all aim to extract some more drops of gains out of our investment. We define one more dimension for cyclic behaviour based on demand generated for a particular type of goods or service in a particular month of financial year.
Few examples of above proposition is increased sales figure of auto companies at the time of Diwali, decreased sales figure of cement stocks in rainy months etc. Year on year we witness the same behaviour for few sectors of the economy which should prompt us to act.
Rationale for investing in cyclical stocks
An investor may argue, as he is a long term investor so why should he bother about cyclical stocks. Economy is growing so he should be immune to short term movements. True, but the rationale behind investing in cyclical stocks is extracting some extra benefit out of same investment.
Let"s take an example to analyze it better. Say, I am a long term investor and I have an investment in an Auto stock. It"s a good company with bright future. I bought this stock at the beginning of the year. As we are now aware that if the economic situation remains positive this company will showcase bright sales figure round Diwali. In anticipation of this enhanced earning, the stock price will start to peak round September because of demand pull. If you are a believer of cyclical philosophy you should sell this stock at this point of time and re-enter the stock round November as all the good news is priced in and profit booking will depreciate the stock reasonably.
So following this philosophy you are not only holding the stock but also have squeezed some profit out of it.
The Trick to find cyclical stocks
Even if you don"t want to research the whole lot of companies to find there cyclical nature with respect to financial year, you can at least analyze the stocks which you are holding in your portfolio. Try to find out what kind of product or services they offer and in which part of the financial year, demand for those products is high/low.
We should focus on financial year cyclical movements as it provides an opportunity to generate profit. Having said that, one should not ignore the implication of short term capital gain tax on such investment decisions.