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Better Buy: Smith & Wesson Holding Corporation vs. Sturm, Ruger & Co.

By Dan Caplinger - May 25, 2016 at 7:47AM

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Which of these gun-makers is the smarter pick right now?


Image source: Smith & Wesson.

Gun manufacturer stocks have done extremely well over the past year and a half, and both Smith & Wesson Holding (SWBI 2.97%) and Sturm, Ruger (RGR 1.04%) have capitalized on strong demand for firearms recently. As the 2016 Presidential election campaign has heated up, so too has discussion about Second Amendment rights, and concerns about the continuing ability to purchase guns freely has prompted periods of increased traffic in the past and could well do so in the near future. With that in mind, investors who are interested in the space want to know which of these pure-play gun companies is the better buy right now. To do so, below we take a closer look at Smith & Wesson and Sturm Ruger, comparing them on a number of metrics to see which one looks more attractive.

Valuation and stock performance

Both Smith & Wesson and Sturm Ruger have done extremely well over the past year, but Smith & Wesson is the clear winner. Since May 2015, Sturm Ruger has given investors a 24% total return, but Smith & Wesson's 57% gains blow its rival away.

After such a strong performance, it would be natural to think that both of these stocks would carry relatively high valuations compared to their earnings. Yet in most respects, the two stocks have reacted to fundamental strength, and so their earnings multiples aren't at ridiculously high levels. Using trailing earnings, Smith & Wesson trades at an earnings multiple of just over 16. Sturm Ruger comes in only slightly higher, trading at 18 to 19 times trailing earnings. Incorporating future expectations, Sturm Ruger's forward earnings multiple is 17, and Smith & Wesson trades at less than 14 times forward earnings estimates. Based on valuations, Smith & Wesson looks like the slightly better buy despite its having outpaced its rival in terms of recent stock performance.

Dividends and return of capital

For dividend investors, there's a clear choice between the two gun-makers. Smith & Wesson doesn't pay a dividend, but Sturm Ruger does, and it's a healthy one with a dividend yield of 2.2%. Moreover, that dividend doesn't particularly challenge Sturm Ruger in terms of its overall income, as it carries an earnings payout ratio of only about 35%. That's a deliberate move from the gun-maker, as its dividend varies every quarter to target a percentage of earnings rather than paying a fixed amount. In the first quarter, Sturm Ruger's $0.48 per share dividend represented 40% of its net income.

However, both Smith & Wesson and Sturm Ruger have found other ways to return capital to shareholders at certain times. Smith & Wesson has opportunistically taken advantage of downturns in share price to do stock buybacks, spending $116 million in fiscal 2014 and $30 million in fiscal 2015 to repurchase shares. Sturm Ruger has made similar moves in a smaller scale, including $24 million in buybacks during calendar 2014. For dividend investors, Sturm Ruger has a clear advantage over Smith & Wesson, and buyback activity isn't regular enough to represent a major countervailing factor.

Growth

Any discussion of growth in the gun industry has to include worries about future regulation, but so far, the fundamentals of the two companies show few signs of slowing gains. In the first quarter, Sturm Ruger posted a 26% jump in sales, and margin expansion helped boost its bottom line by half. Newly introduced products performed extremely well, and inventories dropped substantially as purchase demand outpaced production. Some investors have been concerned that the pace of Sturm Ruger's business isn't sustainable in the long run, but those concerns have existed for years, and the gun-maker has nevertheless found ways to keep its customers coming back for more.

Smith & Wesson has seen similar trends. In its fiscal third quarter, the company reported a better than 60% gain in quarterly net sales, and adjusted net income nearly tripled from year-earlier levels. Increased production volumes in the firearms segment was responsible for much of the gain, and strong gross margin for its accessories division was also helpful in boosting Smith & Wesson's bottom line. It too entered the current quarter with depressed inventory levels, and it increased its guidance for the full year based on expected strong demand.

In the long run, the futures of both gun-makers will hinge on any efforts the government might make to implement gun control regulations and on how purchasers respond to those efforts. For now, Smith & Wesson looks like the slightly better buy for growth-oriented investors, while Sturm Ruger will appeal to those demanding current income. Both will rely on continued demand from customers in order to drive further share-price appreciation.

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Stocks Mentioned

Sturm, Ruger & Company, Inc. Stock Quote
Sturm, Ruger & Company, Inc.
RGR
$64.31 (1.04%) $0.66
Smith & Wesson Brands, Inc. Stock Quote
Smith & Wesson Brands, Inc.
SWBI
$13.52 (2.97%) $0.39

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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