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Collection: Peter Lynch - #41 'Third Category of Stocks; Cyclical Companies'



Cyclical companies rise and fall with the economy.

Typically, they make expensive big-ticket items that people buy when the economy is good. Things like houses, cars and furniture. When the economy is bad and people are worried about losing their jobs, they don’t buy big-ticket items. They are too broke or too scared that they will go broke.

Don’t try to time a cyclical stock if you don’t have intimate knowledge of the business, if you don’t have an investor’s edge. Everyone in Wall Street tries to time cyclical stocks too. Because the stock market looks forward you could be left with a sinking stock even though the company’s earnings are terrific.

You make your best money in a cyclical when earnings go from rotten to mediocre or from mediocre to pretty good. The danger point is when earnings go from great to spectacular. Somewhere between these two points, Wall Street will figure out there is only one way to go, that is for profits to go down some point in the future.

Just don’t buy in the hope. Wait for things to get better, prices to get better, capacity to shrink, inventories to go down, scrap prices to get better. Something ought to be happening. So, you just want to wait for something really to happen and then when it happens it is going to be big.

Let us take a look at Chrysler. In 1990, the company was selling for $10 a share. The economy was lousy. People were talking about Chrysler going out of business. But guess what – the economy came back; everyone’s old car was falling apart.

As people made more money, they started buying new cars and because Chrysler had great products, the minivan, the Jeep and its first new full-size truck in 20 years, the stock was big. In addition, very importantly, the balance sheet was decent in 1990. This was not a company about to go bankrupt.

If it’s a cyclical, you are hoping for a dramatic turnaround in earnings. It is going to happen over two or three years. Earnings are going to go from a loss to huge profit. The stock is going to go up and you are going to get out.

Make sure you are picking a strong company that can survive when the cycle goes down. That means good cash flow and low debt. If its cash flow is spotty or its debt is high and the downturn comes, the company faces the danger of going bankrupt.



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