Four Weapons Stocks and Their Targets

 | Mar 08, 2012 | 5:04 PM EST  | Comments
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Last August, as flash-mob incidents around the country were escalating, I wrote a column about the issue and about the potential for it to be a symptom of broader social unrest.

I concluded that column with the suggestion that investors should consider four companies: Sturm Ruger (RGR), Smith & Wesson Holding (SWHC), Olin (OLN) and Taser International (TASR). Today I will review what has happened to the stocks of those companies since then and what it may indicate for the economy and markets for the rest of this year.

Sturm Ruger has increased 40%, Smith & Wesson is up by 87%, Olin is up by 16%, and Taser is down by 2.5%. Sturm Ruger and Smith & Wesson make firearms, Olin makes ammunition, and Taser makes non-lethal personal security devices.

When I wrote that column, the Occupy Wall Street movement had not yet started. Some of the run-up in their stock prices since then may be attributed to the increase in general social stress made evident by the OWS movement. And gun sales have been steadily increasing for the past few years.

But Olin is up much less than Ruger or Smith & Wesson, and Taser is sideways. This indicates that the increase in the stocks of gun manufacturers is probably more reflective of a simple narrative with few outlets for investors to capitalize on it. If the action were indicative of real underlying social devolution, the prices of Olin and Taser should be up in line with Ruger and Smith & Wesson.

The germane question for investors concerning these four stocks and the symbiotic relationship between them is, which of these two trajectories better reflects the segment? Should the stock prices of Ruger and Smith & Wesson move toward a trend closer to Olin and Taser, or vice versa?

Before answering that question, though, a comparison of the financials of all four companies with their stock market performance is quite interesting. Ruger is profitable, has a price-to-earnings ratio of 20 and pays a 2% dividend. Since the 10-year Treasury yields 2%, Ruger looks attractive.

But Smith & Wesson, also a gun manufacturer, is actually losing money and pays no dividend. In the past six months, though, the performance of both stocks is similar, and Smith & Wesson has actually outperformed Ruger.

Olin is up much less than either of the gun manufacturers, but its P/E is only 7, and its dividend is 3.8%. It also has the largest market capitalization of the four companies, by far, at about $1.7 billion. In keeping with the old Gillette marketing strategy of "give them the razors and sell them the blades," Olin is in the catbird seat with a growing number of gun owners who will need ammunition if they are to make their purchase of any value.

Taser ran up to the $6 range early last December before settling back to the $4 range it's in today. Although it too is losing money, just as Smith & Wesson is, I can't find anything that justifies why investors should treat it differently from other personal security device manufacturers.

Putting aside the individual companies for a moment and coming back to what is causing the interest in the sector, there has been little change in the actual trajectory for the economy. Unemployment is still high, food and energy costs are rising, and home prices continue to decline. Equity investors in general are signaling that good times are ahead. But that sentiment should also be sending these stocks down.

Bond investors are much more cautious, as evidenced by the 10-year Treasury yield hovering in the 2% range. If they thought the economy was rebounding, that yield would be rising.

Another way of considering this is that the equity markets are reflecting an expectation that this time is different and that the economy can begin a secular expansion not led by housing, while the bond market indicates the opposite. When there is a divergence between what stocks and bonds are signaling for economic activity, always go with bonds.

As for the four companies we discussed, I believe it is more probable that Olin and Taser move up toward Ruger and Smith & Wesson, rather than the opposite, as housing continues to languish. Olin looks like a bargain all around. 

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