Are Gun Stocks Headed for a Collapse?

Tue, Feb 5, 2013

Investment In Gun Company

Gun stocks have made a major run.

Smith & Wesson (NASDAQ:SWHC) shares are up 200% since President Obama took office. They’re up 35% in the last year.Collapse Gun Stock 2015

Sturm Ruger (NYSE:RGR) shares have soared nearly 700% since January 2009. And they’re up more nearly 80% this year.

Last week President Obama released a list of Executive Orders targeted at gun control.

The list which contains mostly benign regulatory measures including:

Provide law enforcement, first responders, and school officials with proper training for active shooter situations.

Direct the Attorney General to issue a report on the availability and most effective use of new gun safety technologies and challenge the private sector to develop innovative technologies.

Provide incentives for schools to hire school resource officers.

Launch a national dialogue led by Secretaries Sebelius and Duncan on mental health.

This combination of accelerating demand for a product and multi-year runs in share prices would normally cause contrarian investors to expect bad times ahead for the Hot Gun Investment Sector

Most of the Executive Orders clearly cover small administrative details when it comes to mental health and an excuse to kick more (borrowed) cash into the coffers of bloated school administrations, they have nonetheless sent firearms demand to its highest point since.

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The Real Impact of Gun Control on Gun Investments

We’ll start with the real impact of gun control and potential legislation on the gun companies. There are two major impacts.

First is the total sales. Conventional wisdom would say any increased gun control regulations would likely reduce gun sales. As with most investments, conventional wisdom is terribly mistaken.

First of all, the gun control efforts are in coordination with the leading gun retailers. That’s why WalMart (NYSE:WMT) announced in December that it was halting sales of certain rifles from its web site.

Another leading firearms dealer has joined them. Dicks Sporting Goods (NYSE:DKS) announced around the same time it has “suspended the sale of modern sporting rifles in all of our stores chainwide.”

But as contrarian investors looking for the Contrarian Investment<opportunities, we’ve got to break down the facts about gun control, it’s impact on the sales and earnings of gun stocks, and, what most investors ever fail to consider, how much those are already impacting current expectations for the companies.

As a result of this cooperation between major firearms retailers and the gun control advocates and enforcers, it’s safe to say the eventual efforts will actually be designed to benefit them. So the real impact of the proposed gun control regulation will be to the benefit of the companies being regulated.

The second major impact of gun control initiatives are accelerating current sales at the expense of future sales.

Fears of future supply constraints – either through regulation or production problems – will always create buying panic. That’s exactly what’s going on right now.

So yes, right now, firearm sales are up across the board. And sales to first-time buyers are making up 25% which is broadening the total market.

But you have to ask what happens in a year when those customers who may have been waiting to buy a gun decide to push up their purchase to now?

The answer is not a good one for the earnings of firearms companies.

So we know the real impact of gun control efforts on gun sales won’t be much or very long-lasting.

Now you have to account for the other part of the equation in is that impact properly anticipated by the market. To understand that, just look at what the titans of inaccuracy on Wall Street are thinking.

Let the Analysts Be Your Guide

One of the best indicators we have of when a stock investment sector has run too high or sunk too low is actually by following Wall Street’s cadre of groupthinking analysts.

No surprise. They’re expecting boom times ahead for gun companies. And they’re increasing they’re increasing their expectations for sales and earnings in both of the major gun stocks.

The analysts are steadily increasing their forecasts for Sturm Ruger.

The consensus estimate for Sturm Ruger’s next quarter has increased from 86 cents per share to 94 cents per share. And estimates for its current year has been increased from $3.08 per share to $3.48.

In the case of Smith & Wesson, the consensus earnings estimate for this year’s earnings has risen from  87 cents per share in November to more than $1.04 today. They’ve also increased their estimates for the upcoming quarter from 22 cents per share to 30 cents per share.

These are significant increases in the expectations for gun stocks’ earnings reports.

The total relative increase in Sturm Ruger ‘s quarterly and annual expectations are 9% and 13%, respectively.

Meanwhile, expectations for Smith & Wesson’s earnings only increased 19.5% for the year and 36% for the quarter respectively.

They’re certainly big increases in expectations. But they’re not too big.

A Case of Great and Too Great Expectations

In order to best against a run like the ones the gun stocks have had, we’ve got to see extreme expectations which are either far too low or far too high.

A good recent example is what we spotted when Netflix was hitting an overvalued $300 per share and Wall Street was forecasting the company’s exponential growth years (and impossibly) into the future.

The results were distratous. Netflix shares collapsed shortly after our warning. And since expectations were at such an extreme high, the fall was long and hard. It has been almost two years since the highs and shares are still down almost 70%.

There’s also the fertilizer investment bubble which we spotted in the summer of 2008. The crash which followed caused fertilizer stocks to shed 80% of their value within the next six months.

At the time Wall Street analysts were hiking their earnings expectations by 50%, 60%, or more.

That’s well more than the much more reasonable hikes of between 9% and 36% for earnings in the leading firearms companies.

That means a lot on whether to invest in top gun stocks right now.

The Best Investment Move is Normally the Toughest

Although the major gun stocks like Smith & Wesson and Sturm Ruger have had amazing runs and demand for guns has been accelerated therefore pulling future demand into today (a classic element of an investment bubble), it’s clear expectations haven’t grown too high for the firearms sector…yet.

The best investment opportunities – either long or short – always come at extreme points in the market.

Right now expectations are high. But they’re not at unrealistic heights.

Wait for the extreme highs and lows when expectations are too low or too high and you’ll make much more money from your investments with much less risk.

The gun stock bubble is not at either extreme. They’re just kind of stuck in the middle. And that means the best move to make is to do nothing.

Good investing,

Andrew Mickey
Executive Editor, Contrarian Insights

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