3 gun stocks: Buy, sell or hold?
The Tucson shootings rekindled fears of tighter firearms laws and triggered a surge in sales. What does this mean for gun makers and sellers?
By Jamie Dlugosch, Stockpickr
The shootings last month in Tucson reminded us once again that we live in dangerous world. As horrific as such events may be, there is no changing the fact that guns are a part of our history and will be part of our future.
Sure enough, in the immediate aftermath of the tragedy gun sales soared. In Arizona alone, the FBI reported 263 background check requests on Jan. 10, compared with 164 on the corresponding Monday a year prior. In Tucson a firearms dealer reported that high-capacity magazine sales jumped 500%.
The reason for the jump has little to do with protection or a race to bear arms in a violent society. Instead, the concern of those buying has more to do with the possibility that an event like Tucson will trigger some sort of gun control or worse. It is assumed that liberals will use the event to call for a repeal of the Second Amendment to the Constitution.
Rational or not, Americans do not want to give up their guns. Any threat to the right to bear arms is immediately met with an increase in sales of firearms. It is all very predictable, but is the increase in gun purchases sustainable?
Investors in companies doing business in weaponry welcome the bump.
Stocks of gun makers and those that sell them enjoyed appreciation in share value in the trading days after the shootings. The bullish case for stocks in the group suggests that any calls for gun control will result in a groundswell of demand that will make these companies very profitable.
The situation reminds me of what transpired when it became clear in 2008 that Democrats would be taking control of Washington. Gun sales shot higher and so too did shares of companies in the space. Ultimately, though, the rally petered out, and stocks gave up gains when it became apparent that sales increases were only temporary.
In evaluating stocks, investors need to make certain assumptions. News triggered events as welcome as they may be cannot be counted on. Fear of repeal of the Second Amendment alone is not enough reason to own these stocks.
There must be other compelling reasons, mainly an ability to grow profits consistently and purchasing shares at a sufficient price to ensure appreciation. Let’s look at a few companies that are impacted by gun sales.
1. Smith & Wesson
In the few days after Tucson, Smith & Wesson (SWHC) saw its shares gain, but only slightly. After the knee-jerk reaction, the stock has continued its drift lower. Shares now trade for only $3.73 per share.
This American classic gun manufacturer has been struggling to generate a profit. Over the last year, the company has averaged earnings of only 5 cents per share.
Its share price has plummeted since peaking in the Spring of 2009 at $7 per share. Given its profitability, a 50% loss of market capitalization is more than justified. In fact, only a bull market in the last year has kept shares at current levels.
Analysts expect the company to make a profit of 16 cents a share in the fiscal year ending April 30, 2011. Wall Street is optimistic that the company will make 33 cents a share in the following year. That would represent a jump of more than 100%.
On the surface, 100% growth in profits would be quite attractive to any investor. Does current value offer opportunity? It would seem so.
Shares of Smith & Wesson trade for 22 times the 2011 estimate but only 11 times the 2012 number. That right there suggests that the stock is a screaming buy with or without headlines like Tucson to help the stock along the way.
The only real fear for investors in Smith & Wesson today is what happens after 2012. Obviously that 100% growth is not sustainable, but if management can deliver, say, 15% profit growth, investors at 11 times future earnings would likely profit handsomely. Smith & Wesson is a buy for patient investors.
2. Sturm Ruger
Sturm Ruger (RGR) has fared quite a bit better than Smith & Wesson. Shares of Ruger also enjoyed a pop thanks to the fear of Democrats taking over Washington in 2008. Unlike Smith & Wesson, Ruger has managed to hang on to most of the gains.
The reason for that performance has to do with the ability of the company profit in the current environment. It remains to be seen if those profits are sustainable. Over the last year, Ruger has made more than $1 per share in profits.
Analysts expect the company to make $1.44 a share in the year ended this past December. For 2011, the estimate is for the company to only make $1.30 a share. Wall Street believes the earnings are barely sustainable. The assumption is that Ruger stole future profits to grow to where they are today.
If so, investors in Ruger could be in for a bumpy ride. At current prices, shares trade for 10 times 2010 earnings and 11 times 2011 earnings. Those are reasonable prices, but only assuming the company can grow at some sustainable rate.
This stock looks and feels like a classic value trap. In the short term, operating performance has been strong, but only at the expense of the future. In fact the expectation is that profits will shrink in the current year.
I would avoid Sturm Ruger at current prices.
What about the retail side of the gun story? We know that the shooter in Tucson purchased bullets for his gun at Wal-Mart (WMT). Unless gun sales go completely underground, there is money to be made in sales of weapons and ammunition.
One of the more interesting retail plays is sportsman shop Cabela’s (CAB). In addition to more typical outdoor recreational equipment, the company sells guns and ammo. Can investors make money owning a stock like this?
Shares of Cabela’s have increased by more than 15% in the time since the Tucson shooting, but that may have to do with a strong market and a recovering consumer. Retail is doing very well in the current environment, no matter what is being sold.
Piper Jaffray upgraded the stock last week, citing credit card profitability and positive trends in ammunition and firearm sales. Analysts expect Cabela’s to make a profit of $1.67 a share for the year just ended in December. The estimate for 2011 is at $1.86 per share.
Those numbers suggest steady profit growth of just over double digits. That may be enough to justify the Piper upgrade, but given the current valuation of the stock Cabela’s is at best a hold.
Shares trade for 15 times 2010 profits and 13 times 2011 estimates. Those numbers are fair given the profit expectation for the company, but they're not not a screaming buy. Unlike Piper Jaffray, I would suggest that investors be leery of firearm sales as a basis to own this stock. It is yet to be seen if such jumps in sales are sustainable.
I would hold Cabela’s and wait for a lower price to buy shares.
To see these stocks in action, check out the Stocks for a Violent America portfolio on Stockpickr.
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Why are stronger numbers considered bad news? Investors are worried about the impact on inflation and interest rates.
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