MagicDiligence's  Instablog

Send Message
MagicDiligence provides useful, simple, and effective stock screening tools inspired by Joel Greenblatt's Magic Formula® Investing methodology. Our Spells give value and growth investors a list of great stock candidates every day, and our advanced Spell Caster lets you create the Magic-style... More
My company:
My blog:
  • Gun Stock Shootout: Smith & Wesson Vs. Sturm Ruger 2 comments
    May 17, 2013 6:29 AM | about stocks: RGR, SWHC

    Today, I want to pit two Magic Formula Investing® (NASDAQ:MFI) gun stocks against one another: Smith & Wesson (NASDAQ:SWHC) andSturm Ruger (NYSE:RGR). What is behind the gun stocks' appearance in MFI? Do they look like attractive investments at current prices? Which of the two is better? Let's put them under the scope.

    Boom, Boom, Boom

    Like it or not, firearms are woven tightly into American history and culture. The founding fathers found gun ownership so important that they protected it in the second amendment to the U.S. constitution. Some of the world's most famous guns and gunmakers, from the Colt Single Action to theRemington 870 to the M16, have come from America. At about 40% personal ownership and over 300 million guns, the U.S. easily has the most armed citizenship in the world.

    Recently, the gun industry has enjoyed record demand, with 3 distinct gun "booms" in the U.S. over the past 5 years. The first came in 2008, when the election of Barack Obama sparked fears of increased gun control and even a potential repeal of the second amendment. The second was in 2012, when his re-election became apparent. And the third, ongoing to this day, came after the horrifying school shooting in Newtown, Connecticut, sparked new momentum for gun control laws.

    The tangible evidence is staggering. Background checks are up a staggering 4-fold since 1999. Since 2007, Ruger has grown sales 243% while Smith & Wesson is up 127%. Both firms are running flat-out, struggling to produce enough guns to meet demand.

    Without a doubt, it has been a good time to be a gun maker.

    Dueling Stocks

    So we know the industry conditions are good, but which of the two stocks is more attractive?

    The companies themselves are very similar. Ruger makes essentially all of its dough from firearms, and although S&W is also a big maker of handcuffs, 96% of sales are from guns. Both firms compete mainly in pistols, revolvers, and rifles. Ruger doesn't compete in black powder guns or "modern sporting rifles", where S&W does with its Thompson Center and M&P Sport lines, respectively.

    From a quality standpoint, there is a clear winner - Ruger. While both have enjoyed the boom, Ruger has operated better. We already quoted growth figures, where Ruger has double the revenue growth since 2007. During that period, Ruger has successfully gotten in front of the trends, a notable one being lightweight compact revolvers, something Smith & Wesson was behind the curve on. Ruger has a better balance sheet, with $46 million in cash and zero debt, vs. $62 million cash / $44 million debt for S&W. Ruger's operating margins have been in the 16-23% range during the boom, while S&W's have been about half that. Return on invested capital for Ruger has averaged 63%; for Smith & Wesson, 19%. S&W also went through a debacle of buying security supply company Universal Safety Response in 2009, only to turn around and divest it in 2011! Clearly, Ruger has been a better operator.

    From a value standpoint, though, the opposite is true. Smith & Wesson is a much cheaper stock, with a 9.3 P/E ratio and a 19% pre-tax earnings yield, vs. 13.0 and 12.6% for Ruger, respectively. New management at S&W is making real progress in operations, posting a 20.7% operating margin in the past 12 months, only a few points behind Ruger's 23%. One point in Ruger's favor is the dividend - that company pays a substantial 3.8% yield, compared to no dividend for Smith & Wesson.

    Pull the Trigger?

    If someone held a gun to my head and told me to pick one of the two for investment, my choice would be Smith & Wesson, at least at current prices. Ruger may be the better company, but S&W is the better investment. A cheap valuation is the best determinant of investment success, and SWHC is considerably cheaper. Also, S&W has the longer history (160 years) and better known brands, no small advantages in a market where the collector is a major factor. Finally, S&W simply has more room to improve, and new management is already getting the company back on track and catching up to Ruger's operating standard.

    All this said, I'm still not convinced that current gun demand is sustainable over the long term. In coming up with valuations for these stocks, it is prudent to scale back to 2010-11 volumes when estimating future cash flows. Doing this, I come up with a target around $12 for S&W, and about $49 for Ruger, further supporting the case for Smith & Wesson. In any case, a 25% margin-of-safety on SWHC is a bit tight for what seems like a market in a bubble. Neither of these gun stocks looks interesting enough to enter our Top Buys list right now.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Stocks: RGR, SWHC
Back To MagicDiligence's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (2)
Track new comments
  • Matthew Dow
    , contributor
    Comments (616) | Send Message
    Thanks Steve for the article, I recently published one on SWHC on GuruFocus:



    I think it could be worth between 12-16/share, a little more optimistic than you... I will buy it if dips a bit down towards $8.5 again.


    17 May 2013, 07:52 AM Reply Like
  • SKS1586
    , contributor
    Comments (548) | Send Message
    Thanks a million for your priceless wisdom in the great article.


    Matthew Dow - With Global Central Bank Driven BULL Market in action, $SWHC may not dip to 8.5.
    22 May 2013, 08:35 AM Reply Like
Full index of posts »
Latest Followers


  • MagicDiligence re-launching as a screens and tools site! Useful, simple, effective screens - very low price.
    Jan 25, 2016
  • Why Polaris Is A Great Stock To Buy Right Now $PII $HOG $ACAT
    Nov 12, 2015
  • Funny to see GoPro $GPRO in value-based Magic Formula screens! Stock crashed back to earth, but still grew revs 43% last qtr, has no debt.
    Nov 6, 2015
More »

Latest Comments

Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.