It's a common understanding that the ASX stock market can be volatile. Just look below at how the S&P/ASX 200 Index (ASX: XJO) has moved since June 2006. However, within the ASX 200, there are a few companies that I view as ASX 'volcano' stocks.
Now, clearly, I'm not talking about investing in literal volcanoes — it's an analogy for stocks and industries that have a history of unexpected and extreme bouts of volatility.
Imagine owning a piece of farmland near a volcano like Vesuvius, which caused the devastation of the ancient Roman city of Pompeii. Vesuvius has a destructive history, as do most active volcanoes. However, after an eruption, the land around a volcano can have very fertile soil thanks to the elements released, such as magnesium and potassium.
In other words, farming on land near a volcano can be very fruitful. Until there's an eruption, then it's the worst place to be.
How much is farmland worth if a volcano is erupting nearby? Significantly discounted, I'd say.
Image source: Getty Images
Are you invested in ASX volcano stocks?
Volcanoes typically have a cycle of eruptions. We just don't know when the next one will be. The next Vesuvius eruption could be decades or even centuries away.
Some ASX stocks also experience cycles. These include commodity price cycles (influenced by supply and demand), discretionary spending cycles, debt cycles, and so on.
If we're invested in or researching ASX shares in sectors such as mining, retail, financial, and even technology, we should anticipate some pain along the way.
I would not suggest investing in a cyclical business during a strong point in its cycle.
We can tell when the iron ore price is high (for example, above US$130 per tonne), so I wouldn't choose to buy Fortescue Ltd (ASX: FMG) shares or BHP Group Ltd (ASX: BHP) when the share prices are elevated.
From a long-term perspective, we can see when economy-linked ASX stocks like Adairs Ltd (ASX: ADH) or Credit Corp Group Limited (ASX: CCP) are going strongly.
At some point, a 'volcano' will likely erupt and send those share prices plummeting.
But, for brave investors, the decline in the share prices of these businesses could unlock the best time to invest.
When to pounce
When consumer spending at Adairs stores is limited, this could conversely be the best time to invest because the market is likely pricing the business significantly lower.
Just look at the Adairs share price movement below. The retailer saw a decline of approximately 70% between June 2021 and November 2023, but in the last 12 months it has risen 66%.
There are plenty of other examples like that.
The destruction after one of these 'volcano' eruptions is painful for shareholders but can open up compelling ASX stock opportunities for investors.
However, investors in these ASX volcano shares may want to keep in mind that a few years down the line (or sooner), there could be another eruption.
