Institutional investors tend to avoid cyclical businesses due to their unpredictable nature. Trying to predict when the cycle will turn is almost impossible, which results in volatility, the opposite of what investors like to see.

However, Whitney George of Sprott Asset Management is not put off by these qualities. In fact, George prefers cyclical businesses for bargain hunting. As part of this trade, he believes it’s time to go long asset managers.

He’s quite good at picking winners as well. In the 15 years at the helm of the Sprott Focus Trust, George has earned a net annualized 11.2%, vs. 9.7% for the Russell 3000.

In the December issue of Value Investor Insight, Whitney George talks about his strategy and outlines some of the companies he is interested in today. Below is a brief outline of the interview.

Buying cyclical stocks 

The core reason why George likes cyclical businesses is simple: valuation. While he favors high-quality businesses with a strong management team, balance sheet and industry-leading margins, non-cyclical companies exhibiting these qualities are usually expensive.

The team at Sprott are looking for companies trading at “an attractive absolute valuation,” which they define as “our estimate of a company’s normalized operating earnings divided by its enterprise value.” Companies trading at a ratio in the “low-to mid-teens” qualify. George goes on to say that while such valuations are not always a function of cycles, “basic cyclicality that you can understand is very often a source of mispricing.” This mispricing tends to emerge as “Cycles are difficult for many investors to deal with because they often create short-term disappointments that people hate.”

“I’m basically doing time arbitrage – finding companies where economic, industry or company-specific disappointments prompt short-term investors to sell me their shares at compelling absolute valuations based on what I consider normal longer-term earnings power.”