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Timing the Cycle: How Peter Lynch Made Millions on Cyclical Stocks

By sagebytes —

Peter Lynch's Investment Best Practices: Cyclical Stocks

Understanding Cyclicals

What are cyclical stocks?

  • Companies that prosper in good economic times and suffer in bad ones
  • Make expensive products or luxury items that customers can delay purchasing
  • Examples: steel, aluminum, auto manufacturers, hotels, expensive restaurants, machinery, homebuilders, appliance companies, furniture makers, airlines
  • Not cyclicals: consumer staples like drugstores and fast-food (products people buy regardless of economic conditions)

How to identify cyclicals:

  • Look at earnings charts in Value Line or chart books
  • Growth stocks show steady upward slopes in earnings
  • Cyclicals show earnings that wobble up and down

Timing Your Investment

The optimal time to buy cyclicals:

  • When the economy is at its weakest
  • When earnings are at their lowest
  • When public sentiment is at its bleakest
  • Early stages of economic recovery

Historical performance:

  • In all eight post-WWII recessions, cyclical groups gained 50%+ within five months after market bottom
  • Cyclicals consistently outperformed the S&P 500 in early recovery stages

Using Your "Investor's Edge"

Leverage insider knowledge:

  • 50+ million Americans work in cyclical industries
  • Industry employees can see business turns before Wall Street
  • Pay attention to early recovery signs in your industry: prices, inventories, sales increases
  • Those in temporary-help agencies particularly well-positioned to identify recovering companies

Cyclical Investment Strategy

The profit cycle:

  • Business going from lousy to mediocre: investors make money
  • Business going from mediocre to good: investors make money
  • Business going from good to excellent: smaller gains
  • Business going from excellent to good: investors begin to lose
  • Business returning to lousy: back to starting point

Patience pays:

  • Cyclicals always give second chances
  • Another down cycle will create future buying opportunities
  • Don't be discouraged by missed opportunities

Avoid pessimism traps:

  • Every recession brings doomsayers predicting a depression
  • Remember economic stabilizers: government jobs, Social Security, unemployment benefits
  • College and healthcare industries actually improve during recessions

"To succeed at investing in cyclicals, you have to have some way of tracking the fundamentals of the industry and the company involved." - Peter Lynch