America's Gun Love Boosts Firearm Stocks As Sales Surge

By Aaron Levitt | Updated September 02, 2014 AAA

For investors, the world of "sin" stocks has long been a place to find stable returns. Product categories like alcohol, tobacco and gambling have a recession-proof nature that often makes them portfolio staples. Most investors are OK with holding positions in these vices, despite their "sin" connotations. After all, people make the choice to smoke or have a beer.

The fourth category of sin stocks – weapons and firearm manufacturers – is a completely different animal all together.

Recent bouts of civilian violence across the United States have put the various makers of handguns and rifles in the hot seat from politicians and the public. At the same time, stocks of these weapons producers have been on fire over the last few years. The sector is undergoing a huge game of tug of war, with rhetoric and policy pulling one way and potential returns going the other.

It’s not an easy game to play. But for investors willing to look past the potential moral implications and their own conscience, the firearm sector does offer value for long-term portfolios.

Sandy Hook and Potential Scarcity  

Americans have always loved guns. In fact, there are an estimated 300 million legally owned guns in the U.S. That rate is 70% higher than the nation of Yemen – which comes in second place in terms ownership. That rate of gun ownership is nearly enough to arm every man woman and child in the country.

And since President Obama took office, gun sales across the U.S. have been steadily rising. This may have much to do with the president’s desire to make background checks more effective, limit the number of assault weapons a person can own, and generally toughen the rules for owning a firearm.

However, the real upshot and spike in demand was the 2012 mass shooting at Sandy Hook Elementary school. The incident sparked outrage among policy makers and parents, and yet gun sales surged tremendously. The catalyst was potential bans on certain types of guns and rising background check policies designed to inhibit gun ownership. Seeing potential bans in place, consumers rushed out and purchased weapons and ammo in masses. Scarcity – even “made-up” scarcity – drives up demand and prices.  

And while increased assault weapon’s legislation hasn’t come to fruition just yet, some retailers of firearms have already taken the guns off their shelves. Dick's Sporting Goods (NYSE:DKS) has suspended sales of its semi-automatic weapons nationwide, while Wal-Mart (NYSE:WMT) has taken several styles of assault rifles off its website and removed it from certain locations. Even Facebook (NYSE:FB) has begun banning peer-to-peer gun sales and advertising relating to guns on its popular social network.

Meanwhile, the nation’s two largest pension funds – California’s CalPERs and CalSTERs funds – have begun throwing their collective muscle around and have been pressuring manufacturers to stop producing semi-automatic rifles. This included reducing their investments with private-equity group Cerberus. Cerberus owns the Freedom Group, who manufactured the semi-automatic Bushmaster rifle used in the Sandy Hook shooting.

Continued Growth Ahead  

This scarcity, combined with fears of higher crime related to the poor economy, make for higher and higher gun sales. And when you add in the fact that sport shooting has returned to popularity, there seems to a lot of growth potential. Overall, according to official FBI background checks, more than 1.66 million guns were sold in January of 2014. That’s significantly than the 1.38 million firearms sold in January of 2012 and still leaps and bounds higher than before Obama took office.

Yet there could be still more growth ahead. With a new election cycle coming soon and top Democrat candidates leaning towards an anti-gun stance, the renewed ban-panics could be on again. Additionally, recent gun sales statics have shown that women are purchasing guns more than ever before. According to industry sales data, 80% of gun retailers have reported a rise in female applicants and customers in 2012.

At the end of the day, the National Rifle Association (NRA) estimates that all of these factors will help sales of various guns to grow around 10 million a year for the foreseeable future.

Making a Play

With American’s continuing to buy guns at a rapid pace, investors willing to walk the tightrope of sin stock investing may have some good returns on their side. Over the last few years, the firearm and rifle maker stocks have been on a tear. While slightly slowing sales in the fourth quarter have clipped off some of their altitude, the longer term is still rosy.

One of the rosiest could be Smith & Wesson (Nasdaq:SWHC). The manufacturer managed to produce a whopping 43% increase in its profits during the latest quarter. The key was that manufacturer was able to drop several discounts/promotions and actually raise prices for its firearms due to demand. Additionally, SWHC saw a 30% increase in the number of handgun sales. That could mean that Smith & Wesson has been able to tap into the growing female and first-time gun owner markets.

SWHC stock is already up around 153% over the last 2 years, but shares could still be a bargain. Analysts estimate that Smith & Wesson should be able to boost sales at a 10% growth rate and earnings around 15% over the next five years as it targets the first-time and female gun buyers. That makes it even more of bargain than rival Sturm, Ruger & Co. (NYSE:RGR) at current prices.

While Dick’s Sporting Goods has begun to rid itself of semi-automatic weapons, outdoor and hunting store Cabela's (NYSE:CAB) is emerging as the firearm retailer du jour. During the initial threats of a ban, Cabela’s was able to stock-up on firearms and rifles and continued to see increasing sales. Overall, CAB managed to see a 4.9% increase in total sales and a profit increase of 5.5% for its last reported quarter. Cabela’s did see some softness in gun sales during the quarter – which dropped the stock by about 11%. That gives longer-term investors an opportunity to buy the retailer for a forward P/E of 16.

Chemical manufacturer Olin (NYSE:OLN) may seem like an odd choice for a gun stock pick, but the truth is it’s a heavyweight in the sector. Aside from various chlor-alkali chemical products it producers, Olin also owns the uber-popular Winchester ammunition brand. Sales of ammo have risen along with overall gun sales and ultimately strengthened OLN’s bottom-line. Meanwhile, the boring chemical operations continue to churn out steady cash flows. The firm just recently declared its 349th consecutive quarterly dividend and yields nearly 3%.

The Bottom Line

It’s no secret that American’s love guns. So much so, that even the mere threat of banning their sales has sparked rising firearm adoption. For investors, that can be a good thing. If you can remove the potential moral hang-ups about investing in the sin industry, the gun producers can be a great source of gains. The previous picks – along with ammo maker Alliant Techsystems (NYSE: ATK) – make ideal selections to play the trend.

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