Articles tagged with: Stocks

How to invest in cyclical companies

28 December 2008 Michael Szumielewski 25 Comments Investing

Cyclical companies are companies who are strongly tied to the business cycle and their stocks move sharply up and down when economy turns around. Because of this, they require special handling by the intelligent investor.

Definition of a cyclical company

During recessions and economical downswings the stock market as a whole usually goes down, but a special type of companies suffers most: the cyclicals. Examples for cyclical companies are Caterpillar, US Steel, General Motors and International Paper, all makers of products with a fairly flexible demand curve. Automobile manufacturers, airlines, steel, paper, heavy machinery and hotels are the best examples. Examples for non-cyclical companies are Coca Cola, Proctor & Gamble, and Quaker Oats, all makers of products with a fairly inflexible demand curve. In bad times, people still have to eat and buy stuff for the household. Getting a new car or some new whirlpool parts on the other hand, can be delayed for some time.

Marc Thomson, a friend of mine who works at a big bank here in Munich, Germany, said last week: “A lot of our clients feel it now, the recession is hitting them hard. We’ve seen that before in downturns, but as usual, industries like the steel and automobile industry suffer the most and request new credits. ”

Chart for AAR Corporation
Chart for aviation support company AAR Corporation

Great opportunities ahead

When you look at charts of cyclical companies like the one above, there are always big up and downs. But when economy turns around, cyclicals can outperform growth companies and be great turnarounds. The problem is to catch the right moment of the cycle to buy. Take a second and analyse the chart of AAR Corporation for yourself and you will recognise that after this recession great opportunities will come ahead.

There are two problems when it comes to investing in cyclicals: timing and selection.

When it comes to timing, no one really can predict the economy as a whole and additionally cyclicals tend to doing well many months before the economy comes out of a recession. Best indicators seem to be interest rates and the companies’ financial ratios which show when demand goes up again, but also insider buying. It also helps if you know the industry. But all in all it is quite difficult to catch the best moment for the ride.

When it comes to selection, it makes sense to pick an industry that is due for a bounce. Choose the biggest company for more safety and smaller companies if you want to take some risk. These companies who suffered the most can produce the most impressive returns, but you have to make sure, they also don’t go bankrupt. More than usually, you have to check the balance sheet. An indicators that the company is healthy is for example a strong cash position.

If you do your homework well, I’m sure you can find plenty of good opportunities. While it certainly never hurts to have a college education you don’t need a bachelors degree to find good investments. Solid research, patience and a solid understanding of your limits will go a long way in your success.

How to invest successfully

So, successful investing in cyclicals requires careful timing and a good selection. At this point, it’s time to make a watchlist and be prepared to invest when the recession comes to an end which no one know how long it will take. When taking action, take advantage of cost-averaging by buying the stock for several months and building up your position. To be save, you should also set a stop-loss limit to protect you from loses.

Most of all, never forget the up-and-down nature of the economy. And be careful, some cyclical companies die when it finally comes to a economic slump, because of bad management which thought the good times will go on forever and building up a cash reserve is not necessary. When you decide to invest in a cyclical company, you have to follow the news about the global economy and the industry the stock is in. Also cyclicals are not suitable for long-term purposes because of no protection in recessions. Buy-and-hold doesn’t work here. Please keep that in mind.

It doesn’t mean you’re right, when your stocks go up

3 May 2008 Michael Szumielewski 3 Comments Investing

Today’s article is about the reason to invest in a particular stock and the important fact, that just because a stock went up, it doesn’t mean you are right. One could argue, that when something works, the reason is unimportant, but that’s just not true. For example, if you jump into a lake and don’t know how deep the water is, there are two options: you break your neck or you enjoy your bath. Got it?

There are a lot of bad reasons to buy a stock, almost to much to mention. Let’s discuss a few.

Buying/Selling a stock because it went up/down: This is a common mistake. As written in Do not listen to Mr. Market, the stock market suffers from huge fluctuations regularly. If you want to buy a stock, don’t buy it when it’s totally overpriced. Instead search for great companies with a low price and it will be a successful investment. Also don’t panic and sell because the stock went down. Instead check the fundamentals again and make sure you didn’t overlook something.

Buying/Selling for the wrong reason: Today everything is linked to everything, so we call it globalization.This fact often makes it difficult to understand certain developments. It’s not enough to check out the product of a company and know the local business circumstances any more. You have to know exactly what the company does, understand the business model and figure out which variables are critical for success. The lack of understanding world economics like, for example, the euro/dollar constellation, might bring you into serious trouble and may cause unexpected surprises. Read Investment Research: What does the company do? for more information.

Bad investment advise: Especially dangerous for inexperienced investors who keep asking “What’s your favorite stock at the moment? What should I buy?” Again, check out our article Do not trust analysts and fund managers, which tells you why you should make your own investment decisions. Even if you have a good friend who invests successfully, you should probably not invest in the same stocks, because he buys them for specific reasons, which he monitors regularly. You will probably misjudge the case and make mistakes, because you don’t understand the company like he does. You know probably more about other industries.

Remember, we do serious long-term investing here, so if you have a trader attitude, this conclusions may not apply for you.

On the other hand, you’re not necessarily wrong, when your stocks go down. If you invest reasonably, but the stock market is not ready yet, you can also suffer months/years of falling prices, but in the end the attitude of value investing will be superior.

Reduce your investment risk with the Cost-Average-Effect

22 February 2008 Sören Zschoche 14 Comments Investing

chart-cost-1.PNG

The cost average effect benefit from falling markets.Image we got 5000 USD and we buy GM shares, we buy our stocks at the first red point of the chart above to the price of 37 USD per share. But our investment doesn´t act like we wish it would and finally we sell our stocks at the second red point to the price of 27 USD per share. Bad thing we realised a falling share price of 27 % which would be a loss of 1350 USD.

But there is also a way how to make 1000 USD profit which would be a stock market return of 20 %, with same same amount of money and the same chart. In order to achieve that we use the cost average effect so let me explain. We assume that we start to buy our shares at the first red point to the price of 37 USD per share. But this time we just buy 27,02 shares with the amount of 1000 USD. Raid data recovery would say we always repeat that if the markets are falling and we believe that we have got a new depression. For this example I always bought shares with the worth of 1000 USD at the red marked points.

  • 1000 / 37 USD = 27,02 Shares
  • 1000 / 26 USD = 38,46 Shares
  • 1000 / 21 USD = 47,61 Shares
  • 1000 / 18 USD = 55,55 Shares
  • 1000 / 19 USD = 52,63 Shares

So in March 2006 we got a total amount of 221.27 shares iand if we say we would sell them now at the green point for the price of 27 USD we got an amount of 5974,29 USD.
chart-cost-2.PNG

Sounds good but what´s the catch ? The problem is first of all that you also have to pay more charges for your trader when you trade more. The second thing is that you probably will be very sad when the quotation climbs up just after you bought your first tranche with the price of 37 USD, because you could have earned more. But conservative investors are definitely on the safe side with this principle because you can´t misdo much except you buy a company which crashes. Otherwise you can be happy if the stocks are getting cheaper, because you can afford more shares.