3 Companies Threatened by Regulation

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When it comes to investing, it isn’t always as simple as looking at income statements. Some companies face bigger threats. The businesses of Monster Beverage (NASDAQ: MNST), Smith & Wesson (NASDAQ: SWHC) and Sturm, Ruger, & Company (NYSE: RGR) are all facing significant regulatory issues.

In the worst-case scenario, shares of these companies could fall as regulation curtails their business models. Yet, at the same time, these companies could offer value for those who believe any attempts to regulate their businesses will ultimately fail.

Lawmakers could restrict energy drink sales

Shares of Monster Beverage have tumbled periodically over the last several months, as reports allege that Monster’s energy drinks could have negative health consequences. In October, the FDA was reported to be investigating five deaths that were said to be linked to the consumption of Monster's drinks. More recently, two senators -- Richard Blumenthal (D-CT) and Dick Durbin (D-IL)  -- sent letters to energy drink makers requesting more information about the possible health consequences of ingesting their products.

In the worst case scenario, lawmakers could move to restrict the sale of energy drinks, perhaps imposing age requirements or forcing companies (like Monster) to add shameful warnings to their labels.

Trading near $48, Monster shares are far off from their 52-week high of nearly $84. Yet, the company remains expensive, trading with a price-to-earnings ratio of 26, much higher than the broader S&P 500’s 18. Monster still appears priced for growth, so any regulatory restrictions could have a devastating effect.

The deaths that the FDA was investigating were ultimately labeled adverse event reports: they carried no direct proof that the drinks caused the adverse reactions, only that they happened to be linked to them. What’s more, the number of the adverse reactions seems infinitesimally small compared to the number of drinks that have been consumed. Monster Energy, for example, has sold billions of cans; a few dozen deaths over several years amounts could be just as attributable to statistical noise.

The negative press reports certainly won’t help Monster’s image, but with no solid proof that its drinks are harmful, significant regulation seems unlikely.

Democratic lawmakers are pushing gun regulation

Fear that President Obama would push for gun regulation were a significant factor behind the record gun sales of the last four years. Shares of gun makers Smith & Wesson and Sturm, Ruger & Company have benefited.

Yet, following the tragedy in Connecticut, Democratic lawmakers have actually pushed for stricter regulation, including expanded background checks and a reinstatement of the assault weapons ban. The Senate continues to debate possible legislation. Monday, President Obama called for the Senate to vote on the assault weapons ban, despite the fact that Majority Leader Harry Reid has claimed he lacks the votes to get the measure passed. Most Republicans and some Democrats from conservative-leaning states have been skeptical of additional regulation. Given that the House continues to be controlled by Republicans, any significant regulation seems unlikely.

The bigger threat to gun stocks might be demand exhaustion. Guns are highly durable goods -- a well-cared for firearm can last 100 years or more. Given that they last a lifetime, how many can makers actually sell? Further, if fear of potential regulation has driven gun sales, then getting the regulation over and done with could sap demand. Once Congress has moved on from debating regulation, there will be no looming specter of federal regulation to juice gun sales.

Both Smith & Wesson and Sturm, Ruger & Company are heavily shorted, with short floats of about 24% and 30%, respectively. These companies could face issues with their demand, but regulatory risk seems overrated.

Investing around regulation

The potential for onerous regulation can weigh on shares. Monster Beverage, Smith & Wesson and Sturm, Ruger & Company have all seen share prices affected by the possibility of regulatory restriction. Yet, with all three stocks, the threats to their businesses appear exaggerated. These companies face issues -- Monster remains an expensive stock, gun makers could see a drop-off in demand -- but regulation probably isn’t among them.

Joe Kurtz owns shares of  Smith & Wesson and Sturm, Ruger & Company. The Motley Fool recommends Monster Beverage. The Motley Fool owns shares of Monster Beverage and 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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