Nicholas Pardini's  Instablog

12/27/2012

The shooting at Sandy Hook Elementary School in Newton, Connecticut was an unfortunate American tragedy. Public relations issues have motivated mutual funds to sell off shares in gun manufacturing companies in the name of social responsibility. As a result both Smith and Wesson (SWHC) and Strum Ruger (RGR) sold off over 30% the next week for no fundamental reason. Therefore, I recommend buying gun stocks due to now cheap valuations and stronger fundamentals after the shooting will provide excellent returns.

Valuations and the recent economic performance of Smith and Wesson and Ruger imply that both stocks are cheap. SHWC trades with a P/E Ratio of 9 and a PEG ratio of at a very low 0.41. Even with this recent sell off, the company's debt/equity ratio has fallen 50% in 2012 to 0.27 and profitability has increased from a loss to 11.68% over the same period of time. Return on invested capital is also extremely strong for Smith and Wesson at 30.68%.

Strum Ruger trades at a higher P/E than Smith and Wesson, but it has a much stronger financial position. Ruger has no debt, and a strong current ratio at 3.18. In addition to this Ruger's return on invested capital is higher at 36% and pays out a high dividend yield of 3.02%.

The school shooting contrary to popular opinion is bullish for gun stocks. Even though advocates of gun control have spoken loudly and prominently in the aftermath the shooting, new federal gun control legislation is unlikely. However, the fear of public safety and future gun control legislation amongst the general public have caused gun sales to surge in the month of December. The re-election of President Obama also triggered increased gun sales similar to the reaction to his first election in 2008.

Due to anxieties over an adverse economic climate, increased gun control laws, and potentially a higher degree of civil unrest and violent crime, I recommend gun sales will stay elevated heading into 2013. Ethics driven selling have put major gun producing companies at excellent valuations. Overall, the combination of these factors make it an excellent time to buy gun stocks. When comparing Smith and Wesson versus Ruger, I believe Ruger is the better buy due to a high dividend yield and an overall stronger financial position.

Disclosure: I am long RGR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.