Black Swans and Gun Control

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

The tragedy that transpired in Newtown, Connecticut was a horrible event. There is no way to fully describe the pain or suffering of that day and, for many, the rest of their lives. With hindsight, some will try to sort out the reasons for what happened in an attempt to force logic on an event that has none. Others will try to stop such things from ever happening again by imposing new rules and regulations. At the end of the day, however, nothing will make the pain and suffering from this black swan event go away or prevent another, similar event from happening in the future.

While the mother of the perpetrator was, indeed, a gun enthusiast, making the weapons used accessible, that alone isn't the reason for the destruction. The destruction was caused by a human mind bent away from reality into a very dark place. This, sadly, can't be stopped by anyone. Thus, Newtown was a black swan; an event that was totally unpredictable and yet almost destined to happen, eventually. It has taken a material toll on the gun industry and can be an important lesson to investors.

Ban The Guns
There have been sad events of this nature before, including prominent shootings at Columbine, Colorado and Virginia Tech. These events should have long lasting implications across the United States, but they eventually fade from memory. You can argue for or against stronger gun controls, but weapons are a fact of life. If someone wants to do horrible things, they will find a way. That said, in the wake of each of these horrible, unpredictable events, there come calls for additional gun controls and a fall in the shares of gun makers, such as Smith & Wesson (NASDAQ: SWHC).

The reaction is understandable. No one wants to be associated with such events and the immediate demands to do something are fierce. So investors avoid the current pariah. Even so-called smart money has headed for the hills after Newtown—private equity shop Cerberus Capital quickly announced it was going to “immediately” jettison its stake in Freedom Group, a company's whose weapon was involved in the event.

More Black Swans: Nuclear
The gun industry, however, isn't the only one to experience black swans. Take the Fukushima nuclear disaster. Although the risks seemed obvious after the fact, who could have imagined an earthquake leading to a tsunami leading to a nuclear meltdown? The initial reaction was, as you might expect, to shun all things related to nuclear power. The governments of several countries even publicly stated they would shut their reactors.

Needless to say, companies like uranium miner Cameco (NYSE: CCJ) and Exelon (NYSE: EXC), the largest nuclear power generator in the United States, were immediately impacted. This despite the fact that more modern nuclear power plants were, and are, much safer than the older units, and the overall impressive safety record of nuclear power plants. The problem is, like flying in an airplane, when a problem occurs at a nuclear plant, it is large, very public, and can be devastating to human life. That said, industrial accidents happen all the time and to expect that there will never be such accidents at a nuclear power plant is unrealistic.

Smaller Black Swans: Electric Power Grid
The electric power grid in the United States is another infrastructure asset that is prone to unpredictable impacts from weather. And not even weather men can predict the weather. The most recent hurricane that left thousands without power for weeks is just the most recent example. While the fragility of the grid is well known, when, exactly, it will be hit by weather or human error is not. With a seemingly increasing occurrence, it seems only a matter of time before there is an outage that truly causes lasting damage. Utilities and power companies would likely feel the brunt of that pain in the market.

Black Swans That Were Bound To Happen: Toyota
Another example of a black swan, that is even smaller in scale, is the accelerator issues that saddled Toyota (NYSE: TM) and, primarily, its highly popular Prius. Cars are increasingly complicated and while protections are put in place, there is no doubt that technical problems will eventually occur that cause deaths. The accelerator problem was one that left Toyota with a real reputation problem, even though it was later vindicated in its belief that the issue was user related in most cases. That said, there was a material cost involved both financially and for the company's image.

Toyota isn't alone in the auto space. Ford (F) still feels the pinch of its Pinto whenever a car issue is in the news. Indeed, this car's propensity to explode in car crashes is legendary and will probably dog Ford forever, perhaps rightly so. These are just two prominent examples of the fact that the makers of cars and other similarly complex machines are likely to see manufacturing problems that drag down their shares, eventually.

The Next Black Swan: ?
The thing about black swans is that there is no way to predict them; however their impact and the reactions to them can be huge. For an investor, there are historical precedents to remember and think about when looking at a company. While the potential for a massive problem shouldn't stop you from investing, it is something worthwhile to consider along the way.

For example, it would be logical to consider what would happen if a food company had a major recall—even if that had never been an issue in the past. This thought is beyond a strengths, weaknesses, opportunities, and threats analysis. It is more along the lines of a worst case scenario. While you hope it won't happen, it might be better to think about that worst case happening to your investment before it does to prepare. Indeed, a little forethought can help you decide if a price dip like the one in Smith & Wesson's shares is a buying opportunity, a reason to sell, or an event through which you should sit tight.

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SWHC data by YCharts

Yours,

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ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Exelon. 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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