The Great American Gun Bubble - Part II

Includes: AOBC, CAB, RGR
by: Larry Trefz

Due to the overwhelming interest in the 'Great American Gun Bubble' article published here on SA on February 5, 2013, I will provide some clarifications and further development of the idea I presented regarding the possible bubble in gun stocks.

Many of the questions and statements by the commenters were in reference to my thesis that average gun buyers, as defined by their demographics, simply cannot afford to keep up the current pace of purchases for gun-related products as a share of their income.

As previously mentioned, the gun most in demand--the AR-15 -- has seen a price jump of 60% in a few months. I did further research on the price of .223 ammunition, rather than relying on my memory. I found that I was somewhat incorrect on the $0.40 price per round--that I named in my previous article. The current price appears to be about double that, having risen very rapidly. While I apologize for the inaccuracy, it only goes to further my point that the average gun buyer simply cannot financially keep up with the pace of rising prices and sales. As these buyers' incomes have been flat to deflating in real-money terms over the last several years.

It was stated by numerous commenters that the gun stocks do not seem over-valued using P/E or EBITDA measurements relative to the S&P index--I agree. However, the nature of a bubble generally contains another element, which is what we could call the positive feed-back loop. In a euphoric buying situation where the price of the products is being bid up at a parabolic pace, the earnings of the company will rise along with and generally ahead of the stock price. Thus, the stock appears relatively cheap.

But there is a flaw in this situation, the P/E and EBITDA have been affected by a positive feedback loop of euphoric product buying as a greater percentage of the buyer's income has been directed toward these products than is normal or sustainable. This is the error that will eventually be exposed when the buying mania exhausts itself and the bubble bursts.

For further research, look online at past buying manias such as the South Sea Bubble and Tulipmania. The housing bubble that burst in late 2005-2006 is a great example of the fundamentals being affected by a positive feedback loop.

Please keep in mind that both of these articles regarding the 'Great American Gun Bubble' are concerned with finance and economics and the effects of social behavior on them. These are not ideologically oriented articles.

My previous article stated that in the last four years Smith and Wesson Holding Corp (SWHC) has risen about 300% and Sturm Ruger (NYSE:RGR) has jumped about 700%. Cabela's (NYSE:CAB), a sporting goods retailer is up almost 1000% since its 2008 lows. While there may be more upside for these stocks in the near term, I would look at a short position when the bubble starts to burst.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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