Is Smith & Wesson Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Smith & Wesson (NASDAQ: SWHC  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Smith & Wesson's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Smith & Wesson's key statistics:

SWHC Total Return Price Chart

Source: SWHC Total Return Price data by YCharts.

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

34.0%

Pass

Improving profit margin

212.3%

Pass

Free cash flow growth > Net income growth

111.7% vs. 77.2%

Pass

Improving EPS

57.1%

Pass

Stock growth (+ 15%) < EPS growth

136.1% vs. 57.1%

Fail

Source: YCharts. * Period begins at end of Q4 2009 (Jan. 28, 2010).

SWHC Return on Equity Chart

Source: SWHC Return on Equity data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

43.6%

Pass

Declining debt to equity

(45.8%)

Pass

Source: YCharts. * Period begins at end of Q4 2009 (Jan. 28, 2010).

How we got here and where we're going
Smith & Wesson misses out on a perfect score as a result of its share price growing faster than the underlying earnings per share. However, it's hard to argue with a single-digit P/E -- Smith & Wesson's is 9.7 as of this writing -- and the rest of the company's results are pretty sterling. The question is: Will everything continue to move in the right direction?

Smith & Wesson's come a long way from its history as the gun maker behind America's first revolvers, but in recent years its financial progress has been surpassed by that of fellow gun maker Sturm, Ruger (NYSE: RGR  ) , which has a fast-growing dividend and is also debt-free. Both companies have seen their fortunes soar in the past few years. Whether you wish to attribute it to hoarding over fears of gun control, reactions to a dangerous world, or simply rising interest in recreational shooting, the results are obvious on the bottom line: It may never be a better time to be a gun maker.

However, the best time to be a gun maker may already be past. Despite a recent rejection of assault-rifle bans in Congress, a number of high-ranking politicians have pushed back hard against the NRA and unchecked gun ownership with minimal regulation. The Newtown shooting late last year has been a flashpoint for the gun industry. The post-Newtown plunge in both stocks has been short-lived, as investors appear to anticipate another bluff from tough-talking but weak-kneed liberal politicians. It doesn't help the gun control cause that the American public has no problem holding contradictory opinions at the same time.

Americans are still far more interested in guns for self-defense than in the alternatives, but for how long? TASER (NASDAQ: TASR  ) , the primary non-lethal defense company on the market, has grown substantially over the last year -- to quarterly revenue of $32 million. Smith & Wesson, on the other hand, made over four times as much in the same period, with $136 million on the top line in its latest report. Despite the discrepancy, gun maker guidance has not been as impressive as hoped for, and at least one major retailer -- Dick's Sporting Goods (NYSE: DKS  )  -- has ceased carrying more controversial guns in its stores. One large shareholder, the California State Teacher's Retirement System, has decided to divest its funds of both gun maker stocks, and other large funds may follow. That could keep prices depressed as the companies reach toward all-time sales peaks.

Do you expect gun makers to overcome these political roadblocks or will the combined pressure of gun control supporters and nervous fund managers contribute to long-term weakness in stocks with decidedly strong fundamentals? Your answer will determine how you approach Smith & Wesson as an investment over the coming months.

Putting the pieces together
Today, Smith & Wesson has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

Gun maker stocks might be one defense against unwanted power grabs, but there are plenty of under-the-radar companies making big gains just under the elites' noses. The Motley Fool's new free report highlights three less-than-luxurious stocks the 1% may be overlooking. Just click here to read it now.


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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 23, 2013, at 3:24 AM, lbtoolman wrote:

    There is just a few things you left out of your article. The CS Teachers Retirement System. holdings of Smith and Wesson were only 1.7 Million dollars worth, while holding 4 million of Sturm Ruger. That means they only held approx. 170000 shares. That hardly can hold down the share price.

    Secondly, you didn't mention that S&W has bought back 35 million dollars worth of shares in the last 2 quarters, so by comparison that is 20 times the holdings of CS Teachers Retirement System. So the only reason you used to give an investor pause, is non existent.

    Finally. You should mention the 14 million shares, 23 percent of the float currently held short. Seeing that 2 percent of the shares are held by insiders and the positive direction the share price has been going, there is a possible short squeeze in the making.

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