CExplain the factors that affect the sensitivity of a company to the business cycle and the uses and limitations of industry and company descriptors such as “growth,” “defensive,” and “cyclical”

Question 1

A cyclical firm has earnings that are highly dependent on the business cycle

Answer 1

Cyclical firm earnings are highly dependent on the stage of the business cycle.
– High earnings volatility and high operating leverage.
– Products are often expensive, non‐necessities whose purchase can be delayed
until the economy improves.

Examples: basic materials and processing, consumer discretionary, energy, technology,
industrial and producer durables.

Producers of luxury items tend to have cyclical earnings because consumers typically decrease their purchases of these items during economic recessions. The earnings of firms with high percentages of variable costs are not as likely to be cyclical as those of firms with high percentages of fixed costs (i.e., high operating leverage). A growth industry has demand that is strong enough that earnings remain relatively unaffected by the business cycle.

Question 2

A non-cyclical firm has earnings that are less dependent on the business cycle

Answer 2

A non‐cyclical firm produces goods and services for which demand is relatively stable
over the business cycle. Examples include health care, utilities, telecommunications
and consumer staples.

Question 3

industries (sectors) can also be classified as cyclical or non-cyclical, rather, by their sensitivity to the business cycle.

Answer 3

Cyclical sector examples ‐ energy, financials, technology, materials,
and consumer discretionary.

Non‐cyclical sectors / industry examples ‐ health care, utilities, and
consumer staples.

Question 4

Non-cyclical industries or firms can be classified as defensive (demand for the product tends not to fluctuate with the business cycle) or growth (demand is so strong that it is largely unaffected by the business cycle).

Answer 4

Within Non Cyclical Sector, two subcategories are Defensive and
Growth . Defensive industries are least affected by the stage of the
business cycle. Examples: Utilities, consumer staples (such as food
producers), and basic services. Growth industries are largely
unaffected by the stage of the business cycle due to strong demand:
Apple? A growth industry is typically characterized by above-normal expansion in sales and profits independent of the business cycle.

A defensive industry is typically characterized by stable performance during both expansions and contractions of the business cycle.

Non-cyclical industries are those for which demand is not highly sensitive to business cycles, such as utilities, health care, and food and beverages. Housing and autos are examples of cyclical industries.

Question 5

Limitations of descriptors such as growth, defensive, and cyclical include the facts that cyclical industries often include growth firms; even non-cyclical industries can be affected by severe recessions; defensive industries are not always safe investments; business cycle timing differs across countries and regions; and the classification of firms is somewhat arbitrary.

Answer 5

A limitation of applying business cycle analysis to global industry analysis one region or
country of the world may experience recession while another region experiences
expansion