Time to Buy Gun Stocks? Smith & Wesson Holding Corporation (SWHC) & RGR

Gun makers Smith & Wesson Holding Corporation (NASDAQ:SWHC) and Sturm, Ruger & Company (NYSE:RGR) had a horrible December last year, with their stock suffering double-digit percentage losses. However, with the exception of a tough spell in mid-January, gun stocks have recovered much of the lost ground in 2013. Can they keep going up?

Firearm manufacturers face one big challenge: President Obama’s will to pass stronger gun control laws and to ban assault rifles. Even though assault rifles are not the main earnings-driver for these companies, they are a profitable product. They represent about 20% of both company’s sales and a huge chunk of their past sales growth. Banning assault weapons would only affect civilians, obviously, so it is not fair to say that the gun manufacturers would lose 20% of their sales, as law enforcement and military purchases are also factored in that 20%. At any rate, it is clear that a nation-wide ban on assault rifles would not be good news for SWHC and RGR. Furthermore, public anger at the gun-makers is pushing many institutional investors (like the California teachers retirement system) into telling their fund managers to drop those stocks from their portfolios.

There is, however, a silver-lining to all of this. American consumers are rushing to buy firearms, fearing upcoming restrictive legislation. This will inevitably drive earnings up, and analysts are already predicting very strong earnings growth for this quarter. This sort of demand, however, is unsustainable in the long run, so investors should probably not expect gun company sales to continue growing at current rates.

At any rate, should investors buy into gun stocks now? After all, the stocks look cheap and Mr. Market may have already factored in the possible sales decline if the banning actually takes place. Let’s take a closer look at each of the stocks:

Smith & Wesson

• Current P/E is an attractive 10.47. Future P/E is actually even better, at 9.21. PEG ratio is an attractive 0.29.
• Even though analysts are not particularly bullish on the stock (current mean recommendation is only 2.70), the stock currently has an average price target of $13.33, which implies that the stock could go up about 45% from current price levels.
• The stock has performed well in 2012, but still trades at more than half the price it traded at in 2007. It is also 18% lower than its 52-week high.
• It has consistently beat analyst estimates in the last four quarters.
• It has never paid a dividend to its shareholders.
• On Dec. 11, Director John Furman bought $20,000 worth of shares, and, one day later, President and CEO James Debney bought $50,000 worth of shares. Both insiders bought those shares at prices that are higher than last Friday’s close (Mr. Furman bought them at $9.49, and Mr. Debney at $9.82).

Sturm, Roger & Co.

• Current P/E is 17.75, and forward P/E is 15.91. Both ratios are less attractive than SWHC’s.
• Analysts are either neutral or bearish on the stock. The stock has an average price target of $50, which is lower than the current stock price.
• It is closer to its 52-week high (-7.85%) than SWHC, and has recovered faster than its competitor from the December price drop.
• It beat analyst estimates for the last four quarters (albeit with a lower margin than SWHC).
• It currently pays a dividend of $1.53/share (which works out to a yield of 2.76%). They have paid a dividend to their shareholders since 1990, although there was a three-year hiatus in 2006-2008.
• On Feb. 6 and Feb. 7, President and CEO Michael Fifer sold around 25,000 shares of the company (for a total amount of around $1.3 million).

Bottom Line

Gun makers have recovered some of the ground they lost in December, but there might still be some more room to grow. This year’s earnings will likely be excellent, but legislative challenges might pressure their future results. Even though Smith & Wesson does not pay a dividend, the stock currently looks more attractive (better valuations, more room for price recovery, and insider buying) than its main competitor. Those investors who can handle the uncertainty surrounding the future of these companies should look into these stocks before prices recover.

The article Time to Buy Gun Stocks? SWHC & RGR originally appeared on Fool.com and is written by Alex Bastardas.

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