Shares of gunmaker and outdoor recreation company American Outdoor Brands (NASDAQ:AOBC) have rallied 30% over the past three months and are some 50% above the lows they hit just prior to its fiscal third-quarter earnings report at the beginning of March.

But could this sharp gain prove to be shortlived? Or can American Outdoor Brands continue to impress for years to come? Let's take a look at the Smith & Wesson firearms brand's business to see whether it is a company that can offer investors outsize returns over the long haul.

Woman shooting a pistol at a gun range

Image source: Getty Images.

Firearms, first and foremost

American Outdoor Brands remains primarily a gunmaker, despite having made several acquisitions over the past few years that have changed its focus slightly. Three-quarters of its revenue comes from firearms, and sales fell 60% in the third quarter. They're down 46% year to date.

Even though it has tried to diversify, some of those acquisitions still follow the fortunes of the broader gun market, like laser sight manufacturer Crimson Trace, whose performance management said fell below expectations in the third quarter because the firearms industry was also surprisingly slow.

Yet there is an ebb and flow to the gun market, and while that has been upended by presidential politics in recent periods, there remains in place a largely upward path that demand for firearms follows, and it will continue to march higher over time.

In the near term, you will get some wild gyrations like we're seeing. Looking further out into the future, American Outdoor Brands has good reason to feel confident in its ability to grow.

The great outdoors

Because the gunmaker wanted to smooth out some of those peaks and valleys, it added businesses that could provide it with alternate streams of revenue that might fill in the gaps created by slack gun demand. Knife makers Taylor Brands and Bubba Blade fall into that category, as does Ultimate Survival Technologies, a manufacturer of survival and outdoor gear.

It's still early days and a work in progress, but investors can begin to see how American Outdoor Brands can function as a more diversified operator. Sales in the outdoor products segment rose over 10% this past quarter, or about 7.5% organically, and while not nearly enough to offset the decline in gun sales, it indicates there is the chance for further gains to be made in the sector as American Outdoor expands.

More importantly, the segment carries higher gross margin than firearms, particularly in the current promotional environment in firearms that's necessary to move inventory and maintain market share.

Gross margin for the outdoor segment exceeded 48% in the third quarter, compared to the 23.4% margin in firearms. The gunmaker views this as validating its strategy to diversify because it can help the company move its companywide margin rate back up to historical levels, which typically have been north of 30%, but in the not-too-distant past hovered around 40%.

Father and son sitting in a tent

Image source: Getty Images.

Outside opportunities

American Outdoor Brands also has the chance to outsource some of its excess capacity to other industries, like aerospace. Over the years it has developed expertise in metalworking, plastics casting, and other engineering and manufacturing specialties; though it hasn't come to anything lately, American Outdoor Brands can ramp up production in these areas quickly if it needs to.

While American Outdoor Brands previously said it really wasn't in the market to make more acquisitions at the moment, preferring instead to focus on completing its new distribution centers that will enable it to incorporate the acquisitions it already made, the decision by Vista Outdoor to put its gun business up for sale may provide the gunmaker with a chance to fill a hole in its portfolio.

Smith & Wesson rifles are very popular, and its modern sporting rifles account for around 10% to 12% of revenue, but it has a negligible presence in shotguns. Vista's Savage Arms brand has a respected presence in the shotgun market, so it could be an opportunity for both. No discussions have been reported yet, however.

So is American Outdoor Brands a buy?

Based on the long-term trends in firearms, American Outdoor Brands' growth potential in the rugged outdoor market, and ancillary opportunities elsewhere, there seems plenty of opportunity for outsize gains for investors with a long enough time horizon.

Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.