Cyclical companies refer to companies whose sales and profits are very sensitive to the business cycle. Their income rises when the economy expands and decreases during economic slowdowns. Manufacturers of durable goods and discretionary consumer goods are very sensitive to business cycles. Examples are chemical companies and car manufacturers.
More on cyclical companies
The business cycle consists of four phases: expansion, peak, contraction and trough. Peaks and troughs mark turning points, namely the highest and lowest points of the cycle. However, there are several terms related to the business cycle that we need to know, including economic recovery, economic boom, recession and depression. The initial part of the expansion is called economic recovery , where the economy moves from a trough to strengthening. Meanwhile, the final part of the expansion is called the economic boom . Furthermore, a recession occurs when economic growth falls for two consecutive quarters and a severe recession is called depression.
During the expansion phase, productivity grows, unemployment shrinks and income increases. As more people are employed during this phase, they have more income from both salaries and investments and are less reluctant to spend it. In this period, consumer demand grows and consumer demand will tend to be more diverse than in difficult times.
Demand for products from cyclical companies faces significant growth during economic expansion. Therefore, their revenue and profit prospects will tend to be better than those of defensive companies. In the capital market, investors will hunt for shares of this company, pushing the price up high.
Conversely, a downturn in the cycle forces consumers to prioritize spending. They will reduce several cost items that are not important. Therefore, companies that focus on non-essential products face the greatest risk of losing revenue when an economic contraction takes hold. In contrast, companies like electricity tend to weather economic storms much better, because no matter how bad the economy gets, most will still pay their electricity bills.
Example of a cyclical company
- Companies involved in the production of durable goods, such as raw materials and heavy equipment.
- Producers of consumer discretionary goods, a sector focused on products and services that people buy with additional income. An example is a car manufacturer. Discretionary expenses are easier to cut from consumers’ budgets during tough times than essential costs.
- The aviation industry is also included. In times of strong economic growth, people have more [[disposable income]], so they are more willing to take vacations and take advantage of air travel. In contrast, during an economic contraction, people are much more careful about spending.