I would really like to own Commonwealth Bank of Australia (ASX: CBA) shares, but no matter how much I want to buy in, it is a cyclical business and is widely covered by analysts.
Below, I explain why that matters to investors like you and me.
Cyclical Businesses
Some businesses will see their profits rise and fall in tune with an external factor. Almost all businesses have some element of cyclicality, but others are affected more than most.
A property development company is a prime example. When house prices are going up — a factor the company cannot control — its services are in demand. But when house prices — or the perception of house prices — turn downwards, the business will struggle.
Banks, like CBA, share a similar type of cyclicality. They are 'procyclical', meaning their profits move in the same direction as the broader economic theme. House prices go up, bank profits go up.
But banks are 'leveraged' to economic cycles.
Meaning, it is not a one-for-one movement. If house prices go up 1%, CBA's profits don't go up by the exact same amount (1%).
What's more, it's usually more sensitive to the downside than the upside.
For example, if house prices fall 5%, CBA shares might fall 10%.
There's no science behind that number, but it nicely illustrates what it may mean to the business and its share price.
Why does it matter?
To long-term investors, cyclicality can be your friend. It will allow you to buy into a company at good prices if you are patient.
Yes, Commonwealth Bank is Australia's biggest company. But during the Global Financial Crisis (GFC) of 2008/2009, its shares fell 60%. That's not a typo. It fell 60% in 18 months.
It staged a massive and rapid recovery from those share price lows. But patient investors got a great opportunity to buy in cheaply.
For CBA, it's not just house prices investors need to watch. The cycle of bad debts, interest rates, unemployment, household debt and wage growth (all external factors) don't appear to be in investors' favour right now. Especially, with CBA shares trading at a significant valuation premium to the broader market.
Analyst Coverage
I'll be quick with this one, but analyst coverage is a bad thing. Sure, analyst coverage provides shortcuts for investors who do not know how to value companies.
But if you have 16 analysts (plus thousands of other investors) following CBA's every move, it's highly unlikely that you will be able to buy CBA shares at 'bargain' levels 95% of the time.
The other 5% of the time, markets are panicked (see the GFC example, above).
Why should investors buy anything less than a 'bargain'?
There's no reasonable answer.
With over 2,000 other companies on the ASX, you can afford to be choosy.
