Thread by @katalystwealth

#cyclical businesses 🧵

A detailed thread on how to invest in cyclical businesses so that

- you don’t get trapped at the very peak and
- invest when the cycle is down for good gains in subsequent periods (1/n)

Look at a 10 yrs chart of a cyclical company

Same co., different outcomes for different investors

- 0 return for someone who invested at peak of 2010
- 80% loss who invested at the peak and sold in 2015-16
- 400-700% gain in 1-1.5 yrs who invested at lows of 2016, 2019-20 (2/n)

It's believed that cyclical companies are bad for investment

We too believe the same, until we realized that they are bad if picked up at the peak, but the same company can deliver great returns and in a relatively shorter duration if picked when the business cycle is down (3/n)

We have shared the above chart so that you can see that there’s a clear pattern of stock making a quick 300-700% rise followed by a slow grinding 70-80% fall.

Question is how can we capture the 300-700% up move (4/n)

Look at the P/L numbers of the company

Idea is to recognize patterns in both the P/L numbers and the stock price and use them to your advantage to buy the stock at lows

We have circled years of high profitability with green and years of low margins and losses with red (5/n)

Cycle #1 – Co. reported highest OPM of 32% in FY 11 and the stock made its first peak of ~800 in Apr’10 and Nov’10

Subsequently, margins started declining with the co. recording lowest EBITDA of 10% in FY 16 and reported losses. The stock recorded a low of 110 in Feb'16 (6/n)

Cycle #2 – yr later co. again recorded margins of 30% and PBT of 369 cr. Stock moved up 600% and recorded 2nd peak of 780 in Mar’17

Again a down cycle played out till FY 20 when the co. recorded lowest EBITDA of 6%. Worst margins coincided with stock moving to 110 in Mar20 (7/n)

Cycle #3 – Being a cyclical business, company’s performance has improved again with the EBITDA improving to 28% + and the company recording highest ever PBT of 474 crore.

Stock has also moved up from the lows of 110 to 800-900 odd levels and that too in 18-20 months (8/n)

Important observations:

1. Investors don’t pay attention to the nature of business; however, it’s v-important to understand if the business is low cyclical like FMCG, Pharma; moderately cyclical like banks, auto; or deeply cyclical like metals, commodity chemicals, etc. (9/n)

2. In deeply cyclical and moderately cyclical cos., best time to invest is not when the business performance is great

Rather, periods of bad performance, losses by the company can throw up better investment opportunities with low downside and significantly higher upside (10/n)

3. One important metric that we track for such companies is margins, both gross and operating margins

In deeply cyclical businesses, margins tend to swing from one extreme to another. In general, periods of low margins tend to throw up good investment opportunities (11/n)

4. Selling the stock with deterioration in margins, profitability is equally important becoz after rising 400-800%, such stocks can fall by 60-80%

Disclosure: Indian Metals and Ferro has been used as example for education purpose. It’s not a reco to buy/sell the stock (12/n)