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Don't Be Fooled by Cyclical Stocks

Tracey Ryniec

Welcome to Episode #31 of the Value Investor Podcast

Every week, Tracey Ryniec, the editor of Zacks Value Investor portfolio service, shares some of her top value investing tips and stock picks.

Recently, she’s been having some Twitter and Stocktwits “discussions” with investors about what makes a cheap stock.

Just because a stock has dropped big, even if it’s fallen 50% or more, that doesn’t mean a stock is necessarily “cheap” or a “value.” Certainly, that scenario is one that a value investor would want to investigate further.

Tracey has covered value traps on the podcast before but this week she turns to its devious cousin: the cyclical stock.

Companies are known as cyclicals when their earnings rise and fall with the mood of the economy.

So, for example, a luxury automaker, a motorcycle manufacturer and homebuilders are likely cyclical as their earnings rise when the economy is good and consumers feel bullish enough to buy that new car or new house and their earnings fall when there is a recession.

Cyclical stocks can appear to be cheap, especially when earnings are just starting to decline.

Trinity Industries Isn’t a Value

A good example of this right now are the railcar manufacturers, Trinity Industries (TRN) and Greenbrier (GBX).

In 2016, Trinity looked cheap, as it earned $2.25. But earnings are on the decline due to a cyclical drop in rail car orders that will likely last several years.

In 2017, the Zacks Consensus is calling for $1.30. With shares near $30, and the slide in earnings, suddenly Trinity went from having a P/E of around 13 to having one around 26. It’s obviously not cheap any longer.

How do you avoid the cyclicals?

Keep an eye on earnings estimates. What direction are the estimates moving? If they were going up for years but now are on the decline for years, that’s a red flag.

The Trinity chart is a perfect illustration of a cyclical. This what you don’t want to be buying- at least not before the bottom of the cycle has been hit.

Trinity Industries, Inc. Price and Consensus

Trinity Industries, Inc. Price and Consensus | Trinity Industries, Inc. Quote

If you’re trying to stay away from these false cheap stocks, what should you be buying right now instead?

Look for companies with rising earnings estimates and businesses that won’t be as impacted by an economic slowdown.

3 Value Stocks with Rising Earnings Estimates

1.      Western Digital (WDC) has a forward P/E of 14.5. Earnings expected to grow by 38% this fiscal year.

2.     Seagate Technology (STXA) has a forward P/E of 10.5. Earnings forecast to rise 99% this fiscal year.

3.     First Data Corporation (FDC) has a forward P/E of 12.5. Earnings projected to jump 23% in 2017.

What else does Tracey think about the cyclicals and finding cheap stocks while the market is hitting record highs?

Tune into this week’s podcast to find out.

Want more value investing insights from Tracey?

Check out her weekly Value Investor service to receive more in-depth analysis on value companies and see which stocks Tracey thinks are the best bargains now.

It holds between 20 and 25 value stocks for the long haul.

Click here to learn more.

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Trinity Industries, Inc. (TRN): Free Stock Analysis Report
Greenbrier Companies, Inc. (The) (GBX): Free Stock Analysis Report
Western Digital Corporation (WDC): Free Stock Analysis Report
Seagate Technology PLC (STX): Free Stock Analysis Report
First Data Corporation (FDC): Free Stock Analysis Report
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