Is Now the Time to Jump Back Into Gun Stocks?

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Whether you like guns or not, they seem to be selling like hotcakes. An estimated 2.2 million checks were conducted by the FBI’s National Instant Criminal Background Check System last month -- which makes it the fourth consecutive month of requests over 2 million.

The two most popular publicly traded gun manufacturers are Sturm, Ruger & Company (NYSE: RGR) and Smith & Wesson (NASDAQ: SWHC). After a significant run-up earlier in the year, both stocks have experienced quite a pull-back in price as well:

<img alt="" src="http://g.fool.com/editorial/images/32901/price_large.JPG" />

So, with guns seemingly continuing to be in strong demand, is now a good time to get into these gun-makers after the pull-back?

Fundamentals/valuations:

<table> <thead> <tr><th> </th><th>P/E</th><th>Forward P/E</th><th>Dividend (yield)</th><th>Market Cap ($)</th></tr> </thead> <tbody> <tr> <td><strong>RGR</strong></td> <td>13.31</td> <td>19.96</td> <td>1.62 (3.20%)</td> <td>922.89 Million</td> </tr> <tr> <td><strong>SWHC</strong></td> <td>8.86</td> <td>7.91</td> <td>N/A (N/A)</td> <td>553.05 Million</td> </tr> </tbody> </table>

Taking a quick look, Smith & Wesson currently appears cheaper than Ruger, both now and going forward. Ruger does, however, offer a little more safety with its dividend. Ruger also looks like it has smoother earnings than its smaller competitor:

<img alt="" src="http://g.fool.com/editorial/images/32901/earnings_large.JPG" />

Both companies appear to be on the "up-and-up" as far as earnings go, however, it's contingent upon people buying guns. So what do their balance sheets look like?

<img alt="" src="http://g.fool.com/editorial/images/32901/bal_large.JPG" />

While Smith & Wesson is surely in great financial shape, Ruger is even stronger financially, carrying no debt.

Negative headwinds-- simply bad, or disastrous?

Many perceived negative headwinds have surfaced for gun stocks, as there has been some public and governmental calls for action after recent shootings. Stricter gun laws seem to be a perceived negative for gun stocks, but guns still seem to be moving off the shelf.

The gun control vote now seems to be centered on extended background checks, which wouldn't necessarily devastate gun-makers. The current deal would fail to ban assault weapons. Banning assault weapons would cripple sales more than any background check ever could, so without this ban, the negativity may begin to slowly swing into the positive area with regards to gun stocks. 

A bigger concern for gun stocks, at least in the short-term, may be due to short sellers. An abnormally large number of people seem to expect the price of these gun stocks to tank, and as of late, they have been getting their wish. Of course, things may also swing into the opposite direction -- with a short-squeeze propelling a future gun stock rally.

Either way, almost 27% of Ruger's float is being shorted -- with Smith & Wesson seeing around 21% of its float being shorted, according to Yahoo! Finance. Investing in gun stocks could be playing with fire, but so could shorting them. It all comes down to gun sales and earnings.

Let's take a look at the alternatives...

Gun manufacturers are not the only outlets to get exposure to increasing gun sales. Guns need bullets. It's becoming increasingly difficult to find ammunition nowadays, and demand is soaring. An article on Forbes has even called ammo the next bubble, equating it to gold in the 70s.

Manufacturers are apparently operating at capacity and still can't keep up with demand. Gun stores and big retail suppliers such as Wal-Mart are even beginning to ration ammo -- if they can get any in the first place. According to Forbes, the national shortage of bullets, like the increasing demand for guns, is also correlated to the fear of stricter gun laws. Fear causes greed and hording. Bullets are being horded, even with production picking up.

One ammunition manufacturer that is publicly traded and reaping in the benefits of this trend is Olin (NYSE: OLN). Olin is the manufacturer of the Winchester brand, which is one of its three operating segments -- along with Chlor Alkali Products and its Chemical Distribution segment. Strong ammo sales gave the company a strong boost towards the end of its last quarter.

Olin is also a good dividend stock, paying out a dividend for 345 consecutive quarters. The company's dividend currently yields about 3.20%. Trading at 13 times earnings, the company looks even cheaper going forward -- trading at only about 11 times forward earnings. While the company gives investors exposure to ammunition sales, investors also get exposure to other segments of its diversified business as well -- such as bleach, batteries, and food processing chemicals. 

The bottom line

If you are bullish on increasing gun sales, Ruger and Smith & Wesson are two stocks to consider. I personally like Ruger, because it offers a nice yield and carriers no debt. The shorts looking to tank this stock concern me, however. Increasing earnings and continual gun demand indicate that the stock should be able to recover from the recent sell-off if the positive sales trend continues.

For a more diversified approach, an investor can go with Olin, a major manufacturer of ammunition. While Olin is certainly not a pure gun play, it will give you exposure to the exploding demand for bullets. Olin offers less gun-related upside, as opposed to Ruger, who will likely do a better job of capturing gun growth almost exclusively.

Both pay out nice dividends. As long as gun and ammunition sales continue to explode, both stocks make good plays. The long-term picture, however, remains questionable if gun sales inevitably cool down. Ruger will feel the cold more than the more diversified Olin will.


Joseph Harry has no position in any stocks mentioned. The Motley Fool owns shares of Sturm, Ruger & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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