2 Gun Stocks, 1 Potential Bang-Bang Play

Click to Enlarge Everyone likes a good story stock — and when the �story� involves American citizens arming themselves at a breakneck pace, how can an investor resist? We�re talking, of course, about the shares of the two publicly traded pure-play firearms manufacturers: Smith & Wesson Holding Corp. (NASDAQ:SWHC) and Sturm, Ruger & Company (NYSE:RGR).

Click to Enlarge The two stocks have gained 130.8% and 39.7%, respectively, since Dec. 1, and the recent news flow has been exceptionally positive. But is it too late for investors to jump on board?

The Story

The most recent news propelling shares of the two stocks was Sturm Ruger�s announcement that its order backlog is so large, it would stop taking new orders until late May. The stock jumped more than 13% on Thursday on the back of this exceptional news item, and Smith & Wesson — which has an enormous backlog of its own and is expected to gain market share in the wake of Sturm Ruger�s decision — gained more than 11%.

This portion of the rally only extends a move that has been in place since late last year, when strong demand prompted SWHC to boost its 2012 earnings guidance. The company raised its estimate again earlier this month following an earnings report that came in well above expectations.

The result of this positive news flow has been a sharp rise in earnings estimates during the past 90 days:

	2012 Current	90 Days Ago	Increase	2013 Current	90 Days Ago	Increase
SWHC	$0.27	$0.21	28.5%	$0.40	$0.31	29.0%
RGR	$2.51	$2.10	19.5%	$2.79	$2.50	19.6%

Is There Room to Run?

Click to Enlarge It looks to be a safe bet that the positive sales trends for firearms can continue through year-end. The FBI�s National Instant Criminal Background Check System reveals that the number of firearm background checks rose 15.7% year-over-year in February, well above the monthly average — indicating that recent news events are no fluke.

Click to Enlarge Further, the election cycle represents a catalyst for firearm sales that could run through year-end and beyond. Recall that concerns about tighter gun control after President Barack Obama�s election prompted consumers to go on a buying spree that drove both stocks to massive gains in the first half of 2009:

This time around, recent polls indicate that a second term for Obama is likely to remain a strong possibility for the remainder of this year. With the president having nothing to lose in a second term — the thinking is likely to go — the greater the chance that prospective gun owners will need to buy sooner rather than later. Whether this is true is a matter for debate, of course, but in this case it�s the perception that counts. As a result, firearms sales are likely to remain robust through year-end.

Having said this, both stocks already have registered substantial gains in recent months, and neither is particularly cheap based on current estimates. Smith & Wesson is changing hands at 19.2 times current 2013 estimates, while Sturm Ruger is trading at 17.2 times. While these P/E ratios likely will fall as estimates rise further in the months ahead, at this point both stocks look expensive on a historical basis.

It therefore appears unsafe to chase Smith & Wesson here — especially after its 43% gain so far this month, which has put it a whopping 89% above its 200-day moving average and 33% above its 50-day MA. At these overbought levels, a pullback is in order in the near term. On the other hand, RGR — which had been trading sideways for a month prior to Wednesday�s news — appears less vulnerable to a reversal. It�s also cheaper on a valuation basis, and it sports a 2% yield (versus no dividend for SWHC). Therefore, Sturm Ruger appears to be the better bet between the two stocks right now.

Despite the potential for near-term weakness, Smith & Wesson and Sturm Ruger deserve a place on your radar screen for the rest of 2012. Any selloffs that occur between now and the end of the year are likely to set the stage for a nice counter-trend trade given the underlying strength in the two companies� fundamentals.

And if nothing else, the firearm makers represent an outstanding hedge against a zombie apocalypse.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.