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Gun-maker Smith & Wesson (NASDAQ:SWHC) reported absolutely fantastic results for its fiscal year 2013 first quarter. Sales surged 48% year-over-year to $136 million, well above consensus expectations. Operating earnings per share grew significantly to $0.28, ten cents higher than the consensus estimate. Going forward, the firm expects full-year sales to be $530-$540 million, up from its previous forecast of $485-$505 million and well ahead of the consensus estimate of $498.5 million. As a result of this top-line strength, the firm guided to full-year earnings of $0.85-$0.90 per share, above the consensus of $0.79.

Smith & Wesson has recently focused on adding capacity while increasing efficiencies throughout the supply chain. These efforts and strong new product demand from its M&P line contributed to gross margins growing 880 basis points, to 37.7%. Management is targeting long-term gross margins of 38-40%, so further upside remains. SG&A shrank by only $1 million year-over-year, but fell to 14.7% of sales from 22.9% of sales last year (revealing significant overhead leverage). The firm generated $3 million in free cash flow during the first quarter and now has its highest net-cash position since becoming a publically-traded company.

We've been big fans of the gun-maker, as we believed shares were undervalued during its entire run. However, shares are now fairly valued at current levels. Though the firm is investing $30-$35 million during fiscal year 2013 to increase capacity, we aren't sure if demand will continue to keep up. For one, its current backlog fell sequentially to $392 million from $439 million. Incremental capacity may further reduce backlog (driving sales expansion), but we also think orders could moderate, especially given political uncertainty. Without question, US gun control remains hotly debated, especially after the Colorado Theater shooting over the summer.

Historically, Smith & Wesson has been prone to wild swings in profitability, but we're fans of the US firearm market, which has grown at a compound annual rate of 11% in recent years. The company has one of the highest-quality brand names in the gun world and exclusively imports German gun brand Walther. Though Smith & Wesson trades at a reasonable 12x forward earnings, its share price is now within our fair value range. The company scores a 4 on the Valuentum Buying Index (our stock-selection methodology), so we aren't interested in establishing a new position for our Best Ideas portfolio at this time.

Source: Smith & Wesson Blows Away Estimates