Should You Buy Smith & Wesson After The Correction?

| About: American Outdoor (AOBC)

On Thursday, Smith & Wesson (SWHC) announced its quarterly results, which beat earnings estimates and suggested continuation of strong growth; however, investors punished the company by selling its shares off. This comes to me as a no surprise because it has happened several times in the past. Many times, the company beats estimates by a large margin, continues its growth story, but the investors think "yeah, they posted great results last quarter but how do we know they will continue to post these results as we move forward." The next quarter, the company posts strong results, and once again, the investors wonder if this is the peak for the company, and another sell-off occurs as a consequence.

Smith & Wesson posted $171 million in revenues, which is up 25.8% compared to the same quarter a year ago. The company's revenue was constrained by production capacity rather than demand. Comparable net sales were up by 36.4% which is very strong. The company's gross profit was $72.8 million which indicates gross margin of 42.6%, up from 37.7% in the same quarter a year ago. Last year, the company generated $51.2 million in the same quarter. Smith & Wesson's operating margin was up from 23.0% to 28.1% and the company's operating profit was up from $18.9 million to $26.5 million. Furthermore, the company's operating cash flow was up by more than 50% compared to the same quarter last year ($12 million vs. $19 million).

The company repurchased its $49.2 million debt successfully. The new debt's interest rate is 5.9% compared to the old debt's interest rate of 9.5%. The company also got additional debt in order to finance its massive share buyback activity. Smith & Wesson is expected to reduce its share count by nearly 20% this year. So far, the company spent $15.6 million on repurchase activities and it is expected to spend another $84.4 million. Currently, the company has $146 million in the bank, which is more than enough to fund the repurchases.

Some investors were concerned because the company is using its cash to fund a repurchase rather than increasing its capacity. After all, in the last several quarters, the management kept saying that they can't keep up with the demand and that there is a huge backlog waiting to be fulfilled. While buying back shares is not as desirable as investing in growth, buying this many shares will surely improve the company's per share earnings.

For the next quarter, the company expects to generate between $135 million and $140 million in revenues and between $0.20 and $0.22 per share in net earnings. For the full year, Smith & Wesson expects to generate $615 million in revenues and $1.33 per share in earnings.

The company's share price as of Friday closing was $10.31. Currently, the company is looking at a forward P/E ratio of 7.75. This is outrageously low for a company that has been seeing double-digit growth for the last couple years. As a rule of thumb, when a company's earnings are flat, it is expected to have a P/E ratio of 10, when a company is seeing single-digit growth, it is expected to have a P/E ratio in mid teens and if a company is seeing double-digit growth, it is expected to see a P/E ratio of at least 20. So far, the investors have punished Smith & Wesson so badly that the company is trading as if it will see an earnings decline of 50% in the next few years.

By purchasing back nearly 20% of its outstanding shares, Smith & Wesson's management makes it loud and clear that the company's shares are dirt cheap. One of Warren Buffett's investment strategies involve looking at a company as a whole to see whether it makes sense to buy its shares. For example, Smith & Wesson's current market value is $651 million, it generates $600+ million in revenues and $80 million in net earnings annually and it posts double-digit growth at the moment. If you had $651 million in your pocket, would it make sense for you to buy this company? If the answer is yes, then it makes sense to buy shares of Smith & Wesson.

Those that have been following me know that I've been in and out of this company for a while. I've suggested buying this company when it was trading for around $8 and I sold my shares when it was trading for nearly $13. When I sold my Smith & Wesson shares, I didn't sell them due to valuation concerns, rather, I knew that the investors would start selling off at the first chance after observing behavior of Smith & Wesson investors for a while. The sell-off came after all, and this presents a great buying opportunity once again.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SWHC over 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.