Don't look now, but Smith & Wesson (NASDAQ:SWBI) stock is starting to look cheap.
The trouble with statistics
With Smith & Wesson stock up 37% over the past 52 weeks, that might sound like a surprising assertion to make. And yes, from one perspective, I suppose an investor could argue that Smith & Wesson stock is "37% more expensive" than it once was. But here's the thing: Since hitting an all-time high price of $29.37 back in mid-March, Smith & Wesson stock has slumped 27% and is fast approaching its lowest levels of the year.
What's even more interesting than this math, though, is the reason for Smith & Wesson's sell-off.
More trouble with statistics
The reason Smith & Wesson stock is down, you see, is that the past couple of months have seen pretty steep declines in the sequential rate at which gun buyers apply for government background checks required to purchase a gun. Back in April, Smith & Wesson stock was hit by a trio of analyst downgrades citing a supposed 13% decline in gun-buying background checks via the FBI National Instant Criminal Background Check System (NICS) in March. That falloff in gun-buying applications spooked investors into dumping Smith & Wesson stock (yes, and Sturm, Ruger (NYSE:RGR) as well).
If NICS checks are dropping again today, therefore, it stands to reason that the stock might collapse again. (And in fact, some analysts are beginning to worry publicly about the company's future.)
But here's the thing: If you look closely at the NICS data, what it actually shows is that background checks in March declined not 13%, but 3.5% -- from 2.6 million checks in February, to 2.5 million in March. The really big drops in sequential NICS checks didn't arrive until April (down 15% from March) and May (down 13%).
These statistics really aren't troubling at all
What's more, while sales are clearly dropping sequentially as the year progresses, this is hardly unusual. Historical NICS data going back as far as 1998 shows that background checks always decline steadily from about February or March through June or July of any calendar year -- without exception -- before beginning to pick up again in mid-summer. The more important data to focus on, therefore, is the trend in NICS checks year over year, comparing February 2016 to February 2015 for example, or March 2016 to March 2015, or April, or May.
And what do we see there?
Year over year, NICS checks jumped 40% in February, 25% in both March and April, and 18% in May. If you want to quibble over the numbers, well, I suppose you could say that the year-over-year growth rates are slowing somewhat -- but even at the low end, I know companies that would jump at the chance to get the "bad" news about an 18% jump in industrywide sales.
What it means for investors
Viewed from one perspective -- sequentially -- gun sales may be slowing. The bigger-picture view, however, shows that the market for firearms this year is still going great. What's more, I'd argue that in an election year when gun regulation will likely play a part in both parties' platforms, the chances of gun sales continuing to grow look pretty good.
According to data from S&P Global Market Intelligence, the consensus on Wall Street is that Smith & Wesson's profits will rise about 12.5% annually on average over the next five years. That's a rate more than twice as high as analysts foresee for S&W rival Sturm, Ruger, by the way. Meanwhile, at a share price of just 14.8 times earnings, Smith & Wesson stock still costs less than Sturm, Ruger's 15.9 P/E ratio.
If you ask me, that's an argument in favor of buying Smith & Wesson stock, not selling it.