If the economy is recovering, now's the time to look at cyclical investments -- with one eye on the downside.
If the last 12 months has been a value picker's market then perhaps the next year will be one for those who are adept at identifying companies with earnings about to grow rapidly. The trouble is that this is always true -- and there are too many false dawns with too many blue-sky hopefuls.
That's why many of us prefer to stick to value come-what-may. But as the country emerges from recession, perhaps we can have both.
Value is always my bottom line for me. Value companies see you through the lean times. But they can still have the potential to grow earnings rapidly -- and can also be cyclical. And for anyone who doesn't know what a cyclical stock is, it's easiest to think in terms necessity and luxury. There are certain things we can't really do without whatever the economy throws at us; power, heat, water, food, medicines etc. We may cut back a little in the lean times, but we can't live without them.
Luxuries
Companies providing such services are non-cyclical. So it follows that the sales of cyclical companies depend on whether or not the economy is strong. They do well when people have additional income or, crucially, when they feel well off, confident and optimistic.
We're a way off this, perhaps, yet. But as the stock market looks forward, so the shares in such companies have already started to rally.
At the moment, many pundits are saying that defensive non-cyclical stocks are the place to be. I'm not so sure. A few months ago, I thought the same. But the stock market recovery has seen quite a few of these really get going recently.
Picking a few at random that spring to mind; National Grid (LSE: NG), BP (LSE: BP) and AstraZeneca (LSE: AZN), for example, have all seen big rallies in their valuations. Personally, I've been talking a few profits here and there whilst I seek out companies displaying value characteristics just in case the recovery peters out -- but which also may see an increase in earnings and valuation if it doesn't; trying for the best of both worlds in other words.
Cyclical value
That isn't to say it's time to sell the big non-cyclicals. Many remain good long term value and are obvious picks for high yield investors, but for those craving a little excitement who still like to protect the downside there are quite a few smaller stocks that exhibit value, and the potential for growing earnings if some of the cyclicals start to do well.
Personally, I'm still wary of the High Street. In fact, I'm wary full-stop after the last year. But some credit-crunched cyclicals in industries like construction and related areas, leisure and travel, recruitment, computer software, media, cars and the like -- could start to motor. What is particularly appealing about them is that their price-to-earnings ratios are lower than the market average as indicated by Malcolm Wheatley last week.
A few examples
The trick is in finding companies that exhibit value credentials and which have managed to trade their way successfully through the slump, but which could put on decent spurt given a sustained recovery. Stephen Bland recently pointed out how and why Dart Group (LSE: DTG) looks tempting, since when the shares have slipped back a little.
Timber merchant James Latham (LSE: LTHM), looks good value whatever happens. A sustained recovery in its markets would be a double bonus.
Meanwhile, techie tiddler OMG (LSE: OMG) looks interesting. When I last wrote about OMG in September, I thought the shares looked like a nice combination of value and growth at 20.75p. Since then, the company has signed an agreement with Microsoft and given us a cautiously optimistic outlook with its final results, but the shares are 19.75p.
These are just three that I happen to have come across and researched for investment on the basis that they appear to offer the best of all worlds. But don't take my word for it -- there are thousands of potentials out there. Happy hunting.
More from David Holding:
David owns shares in OMG, Dart Group & Latham.
