Monday, July 26, 2010

Investing in Cyclical Stocks

Investing in Cyclical Stocks

For any value investor schooled at the feet of Benjamin Graham, it's understood that when buying a stock, you want its price-to-earnings ratio -- the measure of a stock's price to its profits -- to be as low as possible. In his classic investing opus Security Analysis, Graham wanted stocks whose P/E ratio was less than 40% of the average P/E for all stocks over the past five years. For Graham and value investors, it was in the low price-to-earnings realm that you found your "margin of safety."

The trick with buying a cyclical stock, however, is to catch the wave just after it's crashed into the shore and the stock price has been annihilated by the end of the boom cycle. You want it when its P/E ratio is high.

Huh? Didn't we just say that low-P/E stocks had the greatest margin of safety? Well, with cyclicals, the reverse is true.

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