The expanding P/E in cyclical stocks

The soaring cyclical

Here’s the rub about cyclical stocks: Their valuations are counterintuitive. They always look the cheapest when they’ve reached their priciest, and look priciest when they’re reached their cheapest.

Take nearly any oilfield service stock from last summer as an example. Transocean (NYSE: RIG) looked dirt cheap via a crude, PEG-style valuation. But savvy investors know that cyclical companies’ profits mean-revert, which is why cyclical stocks’ P/E multiples stay low during booms and high during busts.

In other words, you should be looking at cyclical stocks as their P/Es expand, not shrink.