Has Smith & Wesson Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Smith & Wesson (NASDAQ: SWHC  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Smith & Wesson.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

12.8%

Fail

 

1-year revenue growth > 12%

40.3%

Pass

Margins

Gross margin > 35%

36.4%

Pass

 

Net margin > 15%

12.3%

Fail

Balance sheet

Debt to equity < 50%

30.1%

Pass

 

Current ratio > 1.3

2.86

Pass

Opportunities

Return on equity > 15%

55.2%

Pass

Valuation

Normalized P/E < 20

10.05

Pass

Dividends

Current yield > 2%

0.0%

Fail

 

5-year dividend growth > 10%

0.0%

Fail

       
 

Total score

 

6 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Smith & Wesson last year, the company has doubled its score, as soaring earnings have brought its valuation down, and its margins and returns on equity up. The company has also improved its balance sheet, and the stock has risen more than 40% over the past year.

Throughout the past year, gun demand has been extremely strong, and higher profits have boosted share prices throughout the industry. In early 2012, Sturm Ruger even had to stop taking new orders briefly because it was so overwhelmed by customer demand, and while Smith & Wesson never reached quite that level of order activity, it, too, benefited from the trend.

More recently, though, the renewal of gun-control concerns has had a mixed reaction on Smith & Wesson. Immediately after the tragic events in Connecticut in December, the company's shares plunged on fears that new legislation would limit gun sales. Yet, since then, the stock has made a strong recovery, as those initial concerns appear to have been overblown as any new regulation is likely to be fairly limited in scope.

In its most recent quarter, Smith & Wesson more than tripled its year-ago earnings per share on a nearly 40% increase in revenue. Yet, even projections of a similar rise in 2013 weren't enough to satisfy investors, as the stock fell on the announcement two weeks ago.

For Smith & Wesson to keep improving, it needs to build on its revenue surge, and work at keeping its margins up. If the run continues, then paying a dividend is the next logical step toward becoming a perfect stock.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess, and learning how to separate out the best investments from the rest.

The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report, "3 Stocks That Will Help You Retire Rich," names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

Click here to add Smith & Wesson to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


Read/Post Comments (1) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 22, 2013, at 9:17 AM, parlance64 wrote:

    Nice hit piece. The Fools investment criteria are arbitrary and selective, and applied blindly.

    Why yes, net margin is a wonderful measure, but SWHC was rated a 'fail' for missing by two points. Fools ideal is 15% and swhc came in at 12.8%. What is most shocking, Fool ignores the fact that swhc has very low debt requirements. So, under Fools criteria, a company with 15.1% net margin, but with extremely high leverage and substandard cashflow after debt service would get a 'pass'.

    As to growth. A 'fail'. The same assessment would have been given to Apple. Sometimes investment criteria are better served by looking at near term numbers, or more importantly forward numbers for companies that are growing. The gun industry is changing and investors would be well served by considering why.

    Fool also forgot about the most important measure of cashflow. Swhc has phenomenal EBITDA and is sitting atop a cash hoard.The price/earnings, price/sales, and mcap/ebitda are shockingly low compared to all other gun and tool companies. Long and short of an objective and fair analysis should have shown that Swhc is severely undervalued and deserves more than the 6/10 shrug that was thrown out by the Fool.

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