Successful stockpicking is all about identifying profitable inefficiencies in consensus expectations for a given company or industry—and as much as I hate to say it, the mind-numbing spate of violence we have been living through this year probably makes the gun business one of the most undervalued sectors in the market today.
Tragically, I suspect the motivations behind many of the recent terrorist attacks abroad will lead to more violence. The philosophy ISIS offers is highly appealing to many young, often poorly educated homegrown European Muslims, and it is highly likely that more of them will choose the perceived martyrdom that follows killing “infidels” versus living on the financial, social, and cultural outskirts of their societies. That means more events like Nice (and Paris and Brussels). Meanwhile, here at home, recent assaults on law enforcement in Dallas and Baton Rouge might produce copycat attacks, despite the increased efforts by law enforcement to better serve inner city communities.
After each tragedy in the US, many pundits and some politicians are quick to blame our lax gun laws and easy access to firearms. Right or wrong, these public calls for a crackdown always cause a sharp spike in gun sales. Even though Americans already own more than 300 million guns, people fear legislation will soon limit their ability to purchase arms, so they rush out to acquire more. These buying sprees, in turn, trigger rallies in the stocks of two publicly traded gun companies, Sturm, Ruger (NYSE:RGR) and Smith & Wesson (NASDAQ:SWHC). Yet, despite this oft-repeated pattern, the firearms makers sell at a below market price earnings ratio of 15x and 18x estimated 2016 earnings, respectively.
These relatively low valuations are probably a sign that, like gun buyers, institutional and retail investors believe there is a chance, however slight, that gun sales will be constricted by the government at some point in the future. They might also reflect a negative association between gun manufacturers and other “sin” stocks like tobacco companies. But unlike cancer stick producers, whose revenues have been flattish for years (as a shrinking percentage of Americans smoke), gun industry revenues have been growing, and will likely continue to do so.
Over the years I, too, have been wary of investing in firearms companies. I have never owned Smith & Wesson or Sturm, Ruger and I’ve never traveled to meet with their managements. This gun-shyness has cost me a chance to earn some spectacular returns in recent months. Smith & Wesson is up 30 percent year-to-date. Sturm is up 13 percent. Thankfully, I have not missed out on another personal defense-related stock, Taser (NASDAQ:TASR). I have interviewed Taser’s chief financial officer on multiple occasions at its Scottsdale, Arizona headquarters and I purchased shares in the company several months ago. The stock is up 50 percent this year and, with its dominant position in the body camera market for law enforcement agencies, I expect it to continue rising.
I am strongly considering stocking up on Smith & Wesson and Sturm, Ruger, too. The other night, a politically liberal friend of mine confessed that he was about to purchase a handgun. The constant news of violence had convinced him to put aside his qualms. I suspect he is far from alone. Furthermore, investor concerns about possible gun control legislation are likely overblown. Just as it was when Barack Obama was sworn into office, the industry will probably be helped, not harmed, if Democrats win the presidency. While gun sales will almost certainly spike again as consumers worry about the prospect of new gun control laws, the actual chances of legislation getting through Congress and onto Hillary Clinton’s desk are slim. Barring an electoral tsunami, the House will remain in Republican hands, and, rhetoric aside, Democrats have not shown a strong willingness to act on the issue. Bernie Sanders, who leans left on every social and economic issue, refused to speak out against gun ownership. And most congressional Democrats from Red State America know their constituents love guns, and love the Second Amendment, meaning opposing either would be a quick way to lose reelection.
Additionally, more ISIS-related attacks will almost certainly occur overseas in the coming weeks and months. Europe is facing a bleak future, both economically and culturally. Job creation and economic growth are nil, so the large and growing ethnic populations across the Continent—many of whom are Islamic—have little hope for upward mobility. On top of that, many are dismayed and repulsed by what they view as increasingly secular, morally decadent European lifestyles. That’s why it is homegrown Muslims—not first generation immigrants—who will probably carry out more atrocities in the months to come. That’s terrible news for the world, but it will boost the profits of American gun makers even more.
When people feel vulnerable, they’ll spend whatever it takes to regain a sense of control. And if the last half of 2016 is as chaotic as the first, companies offering that comfort—even if it is merely psychological—will do a very brisk business.