In Gun We Trust

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

In the aftermath of the Newtown massacre, the endless debate about guns and how the second amendment should be interpreted is once again raging all across America. Talk about novelty. I don't believe in cynicism, only in human nature. One of the greatest investors of all time, Charlie Munger, regularly talks about the importance of incentives in order to understand human behavior. The same logic can be applied to the gun issue. If the same incentives regarding gun ownership are kept in place, the pattern of behavior will be repeated identically over and over again.

Guns have become a religion to many Americans. According to the Bureau of Alcohol, Tobacco, Firearms and Explosives, there are now 51,000 retail gun stores in the USA. Sounds like a lot? It is. Compare that to: 14,000 McDonald's restaurants and 13,000 Starbucks stores nationwide. This means that there are almost twice as many gun stores than there are McDonald's and Starbucks COMBINED. Also, there are more licensed firearms dealers in the US than there are major supermarkets! Government records show that in the month of November, Americans tried to buy 2 million new guns, a 20% increase from last year. And if you add to those numbers all the weapons acquired from unlicensed firearms dealers; these statistics almost double. Who says the Old West days are gone?

Now the debate on gun control is back on the table once again. But don't get fooled by this: no politician, not even the President of the United States, will be able to harm the gun industry in any meaningful way. Doing so would not only be political suicide for any American politician seeking reelection in a country where 53% of all households own a gun but it would also be inconceivable from an economic standpoint because a thriving gun industry creates a  huge number of jobs and millions of Americans depend on it in some form or another. In times of economic uncertainty when employment remains the major priority of the government, taking on the gun industry will not be the type of policy that would appeal to Washington. Which brings me back to the point made by Charlie Munger: incentives have not changed; therefore don't expect the behavior to change.

No end in sight for the gun bull market

So what should an investor do about this reality? First of all, keep his emotions at bay and recognize that there is a basic economic principle at play here: if most people believe that supply of a certain good will come under pressure in the near future for whatever reason, then demand for that very product will go up and so will its price. With every new mass shooting taking place in America, speculation over stricter gun laws gives gun sales a boost. It is unfortunately no coincidence that the Bushmaster AR-15, the model of rifle used at Newtown, is now almost sold out in gun stores since the carnage. The recent pledge made by President Obama to launch a committee headed by the Vice President to push for tougher gun control will cause gun sales to rise even more. It's human nature.

The second thing you must do is ask yourself: « cui bono » from all this? Obviously major gun companies such as brand names Smith & Wesson (NASDAQ: SWHC) and Sturm, Ruger & Co. (NYSE: RGR), but also brand retailers such as Wal-Mart (NYSE: WMT). The Bentonville behemoth has reintroduced firearms to many of its stores in April 2011 as part of a strategy to revive sales growth at its locations in the US. So far this decision has been very successful. Wal-Mart stores posted their first gain in same-store sales in more than 2 years in October 2011 and according to Bloomberg News, at an analysts meeting in October, the company expressed that gun revenue gained 76% in the first half of fiscal year 2012. This might explain why Wal-Mart has already announced after the Newtown tragedy that it would continue to sell guns, including the Bushmaster AR-15 model.

Buying into gun manufacturers

Buying shares in companies that manufacture firearms are another way to benefit from rising gun sales. In that respect, Sturm, Ruger & Co. and Smith & Wesson are heavyweights in their field. Smith & Wesson provides products and services for safety, security, protection and sports in the US and internationally. Based on their own projections, the company expects a 40% gain in revenue for 2013. Its stock price is up a whopping 83.7% and has doubled in value since President Obama first took office in 2008. The company is doing very well with a profit margin at 11.16% and a return on equity of 45.92%. However, the most appealing aspect of S&W is the fact that its P/E ratio is still relatively low at 9.48 and its PEG ratio at only 0.37 would have made Peter Lynch take off his glasses and weep with joy!

Sturm, Ruger & Company, Inc. is another good bet. It engages in the design, manufacture and sale of firearms in the US. According to most gun experts, Ruger is more affordable than S&W because it makes cheaper products at equivalent quality. The company posted a 63% rise of its EPS on 3Q2012 and analysts expect a 43% increase for this quarter. While holders of Ruger shares had to endure a selloff during the month of May, the stock now seems to be back on track. It has increased by 32% this year and has more than quadrupled since Obama became President. Ruger has a higher P/E ratio than S&W (14.03 compared to 9.48) but its profit margin is higher (13.84%) and the stock is less volatile: Ruger has a beta of 1.07 compared to S&W's beta of 1.20.

Bottom line, politicians can come out on TV after every mass shooting and make bold statements and promises about fixing the problem but nothing will change in the next couple of years in America as far as guns are concerned because both parties benefit by preserving the status quo. Eventually the Democrats could end up passing a law banning assault weapons like the one they voted in 1994, but with the GOP still in control of Capitol Hill this would not happen before 2014. Until then gun sales in America will continue to shoot through the roof and as an investor you would be wise to adjust yourself to that reality.

PierreDV has no positions in the stocks mentioned above. 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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