Can the SSG Be Used on Cyclical Stocks?

Q. Can the NAIC system of analysis be used on cyclical stocks? I live in Canada, and a good percentage of the stocks on the Toronto Stock Exchange are resource stocks.

A. Yes, while the Stock Selection Guide is a tool aimed at analyzing growth stocks, it is possible to use the SSG to analyze cyclical stocks. If you accept that a typical business cycle is about five years long, then the ten year historical graph of earnings and sales should be able to indicate the peaks of the two past cyclical periods. You can use these historical peak points to project a peak that the next cycle should reach in the next five years. With cyclical companies, it's important to have a good understanding of the company's business operations so that you can determine that the company is really being impacted by the cyclical nature of their business line, rather than suffering from bad management decisions.

Also, you'll want to note that the time to buy a cyclical stock is when its Price/Earnings Ratio is higher than the stock's average P/E Ratio. This may seem counter-intutitive, but when the EPS of cyclical companies are depressed, stock prices don't usually follow at the same pace since the market recognizes the cyclical nature of the company's business. But when the P/E is high, and EPS are low, then the upward part of the cycle may be about to begin.