The Zulu Principle: Making Extraordinary Profits From Ordinary Shares by Jim Slater

Author:Jim Slater [Slater, Jim]
Language: eng
Format: epub
Tags: Business & Economics, Investments & Securities, General
ISBN: 9780857190925
Google: LXlPl0rAOQYC
Publisher: HarrimanHouse
Published: 2010-12-14T20:21:53+00:00

11. Cyclicals And Turnarounds

Most companies benefit from an upturn in the economy and suffer if the economy turns down. However, a really great growth stock will usually manage to produce increased earnings even in the depths of a recession. Some companies with strong business franchises seem to be amazingly unaffected by the gloom and despondency around them. Cyclical stocks suffer much more than most – building and construction companies, steel companies and automobile manufacturers and distributors cannot buck the trend. The most they can hope to achieve is that at the top of the next cycle, they will be ahead of their previous peak, and at the bottom be better placed than last time around.

Hair-raising stuff, but there is plenty of money to be made if you can get your timing right. To do this you have to understand the anatomy of business cycles. Let us take house building for example. At the bottom of the cycle a few survivors in the business will benefit from reduced competition and begin to turn the corner. They would be finding that prime land and labour were far easier to acquire and, therefore, much cheaper than during the boom. Fewer houses would be under construction, so the prices of those being sold would be more favourable to the builder, providing healthier margins and better profits. Other entrepreneurs aware of the growing opportunity would set up as builders or expand their existing building businesses and would compete for both labour and land. Cost pressures begin to increase. Some of the builders borrow to stock-pile land which is becoming more difficult to acquire and therefore more expensive. Very soon, there is over-capacity in the business, so some house builders slash prices to maintain market share. Margins erode due to lower prices and increased costs. The banks, fearing their loans are in jeopardy, foreclose on the more marginal businesses, which become bankrupt. Some of the more entrepreneurial builders decide that there may be better opportunities elsewhere. Competition falls away, pricing pressures ease and profits begin to improve. The cycle starts all over again.

Clearly, the time to buy is before profits rise and the time to sell is when conditions are obviously improving. The important point to grasp is that a cyclical stock should never command a very high multiple and a low dividend yield near to the top of the cycle. Let us look at GKN, a typical cyclical stock, to see how its profits and share price were affected by the last two business cycles.

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