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Is Smith & Wesson Wasting Your Money?

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Stock buybacks are generally considered a bullish signal on Wall Street. They return capital to shareholders, while declaring management's belief that its own cheap shares are its best return on investment. As long as profits remain consistent, share repurchases can even increase earnings per share, by dividing the same amount of earnings among a smaller pool of shares outstanding.

But don't forget -- a company isn't obligated to repurchase shares just because it announced its intention to do so. So don't use the announcement as a reason to buy by itself. Rather, use it as a launching pad for additional research.

Returning value
Having blasted through a $20 million share repurchase program it had just announced on Dec. 6, gunmaker Smith & Wesson (NASDAQ: SWHC  ) added another $15 million buyback plan in an effort to continue returning value to shareholders. With its stock losing about a quarter of its value in the wake of the Sandy Hook school shooting, it believes its shares are significantly undervalued. I have to agree.

Sure, there's a lot more talk about gun control, and Vice President Biden hinted that President Obama may use executive orders to achieve his goals, but there's definitely no consensus that the public actually wants stricter gun laws, and if attendance at gun shows and reports from firearms dealers are any indication, people are loading up their arsenals to protect themselves.

Playing defense
Many gun owners have been suspicious of Obama's intentions ever since he was first elected, and with the tragic shooting last month so soon after his re-election, when he no longer had to try to woo voters, the mood has not improved. According to FBI statistics, the number of background checks done for firearm purchases nearly doubled in November and December from the year-ago period.

Gun sales have been strong for some time now, partly as a result of the presidential elections, but also out of fear of rising crime rates. Indeed, Sturm, Ruger (NYSE: RGR  ) faced a period where it was unable to keep up with demand because it was so strong. Concealed-carry permits are also rising.

Although the gun industry is obviously the most prominent business in the crosshairs of politicians, the video-game and entertainment industries are also getting a dose of criticism for the violence they routinely portray. Activision Blizzard (NASDAQ: ATVI  ) , Electronic Arts (NASDAQ: EA  ) , and other game makers are targeted for portrayals of violence in popular first-person shooter games such as Call of Duty and Medal of Honor, while Comcast (NASDAQ: CMCSA  ) , Time Warner (NYSE: TWX  ) , CBS (NYSE: CBS  ) , and the other networks are criticized for their cavalier attitude toward murder and mayhem. After all, exploring the "human side" of a serial killer, as Dexter does, or setting up women for rape and murder week after week on Criminal Minds, has even brought out harsh critiques from the actors themselves.

Voluntary limits to sales
But guns, obviously, are the main target of those who see this as a pivotal moment in their campaign to crack down on gun ownership. When major gun sellers such as Wal-Mart (NYSE: WMT  ) voluntarily limit the sale of guns in stores in and around Newtown, Conn., you understand they're respecting the sensitivities of the victims' families. The decision to do the same at Dick's Sporting Goods (NYSE: DKS  ) on a national level, though, is seen more as caving in to the changing winds of public relations.

But it's likely to backfire on them, as it did when Wal-Mart stopped selling guns several years ago and witnessed a drop in overall sales. There was a lot more to it than just the gun angle, but sales certainly surged after it reintroduced guns at almost half of its stores a few years later. Buyers could always turn to Cabela's (NYSE: CAB  ) and other sellers and avoid having to go to Dick's altogether.

On target
At just nine times earnings and estimates, Smith & Wesson looks cheap, particularly as sales and backlog are booming at the moment. Without a real national consensus that more needs to done on guns other than perhaps enforce the many laws that are already on the books, S&W should continue shooting out the lights. Its enterprise value may be elevated at 18 times the free cash flow it produces, but with demand at all-time highs, it's likely it will grow into its valuation.

I see a solid next quarter ahead, but let me know in the comments section below whether you agree Smith & Wesson can defend itself against attempts to harm its business.

While Activision and Microsoft have been taking the headlines when it comes to console gaming, Fools following the gaming sector would do well to also keep tabs on Electronic Arts. We can help. Our new special report breaks down the risks and opportunities facing the company to help you decide if EA is right for your portfolio. Click here to get your copy now, and we'll throw in a year of free quarterly updates as news breaks.

Read/Post Comments (2) | Recommend This Article (4)

Comments from our Foolish Readers

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  • Report this Comment On January 14, 2013, at 2:15 AM, Bullseye223 wrote:

    SWHC reminds me of Phillip Morris after the CANCER settlement and BP after the Deep Horizon disaster. Like those stocks SWHC is way oversold. Add to that blowout sales and increased backlog and the shorts will be running for the hills. Gun legislation, if any is likely to be greatly watered down as long as the republicans have the House. BUT NOW NOBODY BELIEVES OBAMA IS FOR PROTECTING THE 2ND AMMEMDMENT. (Check out his campaign promise in 2008 when Biden accused Obama if being anti gun.) GUN SALES WILL BE AT RECORD LEVELS FOR AT LEAST ANOTHER 4 Years. THEN COMO WILL BE RUNNING FOR PRESIDENT. OMG

  • Report this Comment On January 14, 2013, at 5:30 PM, marlinsrundeep82 wrote:

    As a SWHC shareholder and a gun enthusiast alike, I have noticed the recent fall in shareholder's value as lines get longer and longer at all of the gun shops and shows and scratched my head. The monster up in Sandy Hook can be squarely blamed as the culprit. In this hysteria, gun and ammo prices are skyrocketing, and the general public seems to have no problem shelling out the extra cash. I agree with Rich, SWHC is extremely oversold and should be hovering around $12-13. Be prepared for another lights out quarter.

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