Companies whose earnings tend to fluctuate sharply with their business cycles are issuers of cyclical stocks. When business conditions are good, a cyclical company’s profitability tends to be high and the price of its common stock tends to rise. When conditions deteriorate, the company’s sales and profits often fall sharply and/or rapidly. The timing of an investment in cyclical stocks is therefore very important.
Keep a close watch on inventories, and the supply-demand relationship. Watch for new entrants into the market, which is usually a dangerous development.
Anticipate a shrinking p/e multiple over time as business recovers and investors look ahead to the end of the cycle, when peak earnings are achieved.
If you know your cyclical, you have an advantage in figuring out the cycles. (For instance, everyone knows there are cycles in the auto industry. Eventually there are going to be three or four up years to follow three of four down years. There always are. Cars get older and they have to be replaced. People can put off replacing cars for a year or two longer than expected, but sooner or later they are back in the dealership.