When market is having a correction and is trading for low prices, it is very easy to find good value plays. On the other hand, when market is at (for Dow Jones Index) or near (for S&P 500 Index) all-time high, It becomes much more difficult to find good value plays, because a lot of stocks become either overpriced or at least fairly priced at that point. Smith & Wesson (NASDAQ:SWHC) provides one of those great opportunities to get a growth stock for a really cheap price when the market is nearly peaking.
Putting all politics aside, the company's products see very strong demand, and the strong demand will not be going away anytime soon. We are looking at a company that grew its revenues by 39% in the last quarter, raised its guidance for another year of double-digit revenue growth, and this company still trades for a single digit P/E ratio. Apart from Apple (NASDAQ:AAPL), Smith & Wesson is truly one of the cheapest companies out there.
According to Smith & Wesson's latest guidance, the company is expected to grow its revenues by another 40% and it is expected to earn $1.18 per share. Given the current share price of $9.20, we are looking at a pretty cheap stock. Typically, companies that can grow its revenues and earnings by 30-40% year on year will be assigned a P/E ratio of 20 or more. As a general rule, a P/E ratio of 10 implies that a company's revenues and earnings will be flat for the next few years. A P/E ratio below 10 implies that a company will see revenue and earnings drop and a P/E ratio above 10 implies that investors believe that the company will see revenue and earnings growth. This company already beat the latest estimates and gave guidance that suggest a lot of growth, yet investors price the company as if it will see no growth, or even as if it will see some earnings decline. Given Smith & Wesson's huge backlog that will take years to clear, I don't see the company seeing an earnings decline anytime soon unless its production sees some major disruption due to a natural disaster or something.
According to the earnings call that was held recently, the company is working on increasing its production rate in order to address the backlog, even though the specifics of the increased production capacity were not mentioned. It was said that one of the production plants has been working on full capacity for the last 4 quarters straight. It looks like the demand increases at a much faster rate than the company is able to increase its production. On a positive side, the company's profit margin was up from 30% to 37% in the last quarter as a result of conservative growth of its production capacity. If the company ramped up production too fast, its margin growth might not have been that great. Also, keep in mind that Smith & Wesson's margin growth came despite the company spent significantly more money on research, development and marketing in the last quarter compared to the quarter before.
Currently, Smith & Wesson doesn't have dividends, but the company is actively buying back shares, which makes each share more valuable as years go by. The company already spent $20 million on share repurchases and plans to spend another $15 before the fiscal year ends. The number compares nicely with the current market cap of Smith & Wesson, which is around $585 million. At the current rate of generating cash flow, the company will be able to pay off all its existing debt in a matter of few years. Currently, Smith & Wesson has $58 million in cash and $44 million in debt and the company is able to generate free cash flow of $20 million per quarter. Once the company pays off its debt, not only it will be able to afford a higher P/E ratio, but it will also be able to afford more share repurchases and even start paying dividends.
Since announcing great results and increasing its guidance, the share price for Smith &Wesson declined by 13%. This was mostly due to fears of a possible ban on assault weapons. On Thursday, The Senate Judiciary Committee agreed to ban assault weapons, which added up to the plunge of the stock. First, I don't think this will pass in the Senate, second, even if it passes the Senate, this will not hurt the company's sales that badly. After all, Smith & Wesson sells a variety of products, including but not limited to assault weapons. If assault weapons are banned, the gun buyers will not simply stop buying guns, they will just switch to different kinds of guns.
This is a solid company with solid growth and strong demand. While Dow Jones nears 14,500 and S&P 500 nears 1600, it is incredibly difficult to find cheap stocks but Smith & Wesson provides another opportunity for value investors.
Disclosure: I am long SWHC. 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.