After a nearly two-year slump, firearms manufacturers are set to see sales rise again.

The industry went through a contraction following the election of President Trump, which dissipated the urgency to buy guns to avoid new restrictions on ownership. But after 20 months of mostly lower sales, it looks like the gun industry has reached an inflection point.

Dollar sign surrounded by bullets

Image source: Getty Images.

Gun stocks are rising again

The past month has found gun stocks surging higher. Since their close on Aug. 1, and through their close on Sep. 4, here's how these publicly traded gun stocks have performed:

  • American Outdoor Brands (SWBI 0.44%): up 54%
  • Sturm, Ruger (RGR 0.81%): up 23%
  • Vista Outdoor (VSTO 1.34%): up 17%

Why such a dramatic surge in valuation in a month? As I see it, there have been three primary catalysts:

1. Demand is rising

Smith & Wesson owner American Outdoor Brands reported earnings last week that shocked Wall Street with their strength, and the market sent its shares soaring 43% on the news. Sales rose almost 8% to $138.8 million, as firearms sales rose 6% year over year. It also turned a profit of $0.14 per share, compared to last year's loss of $0.02 and ahead of Wall Street's estimate of a $0.12 profit.

That followed Vista Outdoor's own better quarterly results, which saw firearms sales rise over 8% even as its much larger ammunition division suffered a 10% decline.

And Ruger reported that estimated unit sell-through of its firearms from independent distributors to retailers rose 5% year over year, even though revenue was down 2.7% in the period. Unlike other gunmakers, all of Ruger's firearms are sold through distributors. It was Ruger's earnings report on Aug. 1 that began the cycle.

The gains by the firearms manufacturers come as the FBI National Instant Criminal Background Check System (NICS) saw a 5% rise in the number of investigations conducted in the second quarter. But the National Shooting Sports Foundation's adjusted NICS numbers were down 8%. The NSSF data is considered a better barometer of consumer gun-buying demand because it eliminates checks on gun owners who were already issued permits to see if they were still eligible. In any case, this should be the bottom of the trough investors have waited for.

Chart of adjusted NICS background checks

Data source: National Shooting Sports Foundation. 

2. Discounting is discontinuing

Ruger CEO Chris Killoy noted that a year ago, the gunmaker had to have three sales events to move product, but this year it didn't need a summer promotion because market conditions improved. He also said that inventory was down 40% from last year and that Ruger would be increasing production in the back half of the year.

It was not all that different at American Outdoor. It went up against a big promotion last year to clear out existing M&P Shield weapons to make room for the new Shield 2.0 model, which created a tough comparable to match. But it was able to enjoy gross margins widening to 37.8% from 31.5% in part because of lower promotional costs.

Vista Outdoor also limited its discounting, primarily on ammunition, which it said caused sales to be down for the period. CEO Christopher Metz said Vista stopped giving quarter-end discounts on large orders for the first time, and customers held off on buying to see if it stuck by the policy.

Vista has announced it is looking to exit the firearms business, but will keep selling ammunition, so discounting didn't make sense anymore because it resulted in lumpy results. Firearms sales, however, have grown for two consecutive quarters now.

Handgun under padlock and chain

Image source: Getty Images.

3. Emotion drives the industry

The healthier environment was no more evident at the retail level than it was at Sportsman's Warehouse (SPWH -1.06%), which enjoyed an 8.3% bounce in firearm unit sales, allowing it to gain market share. Because competitors like Dick's Sporting Goods, Walmart, and Kroger all vowed to stop selling modern sporting rifles (MSRs) earlier this year after the school shooting in Parkland, Florida, gun buyers turned to retailers that maintained their commitment to the industry. MSRs  remain one of the most popular rifles on the market today.

Midterm elections are approaching, and that might get gun buyers thinking about the possibility of the tide turning again in Congress. American Outdoor CEO James Debney still sees slower growth ahead for the gun industry, particularly compared to two years ago, but that could change once again.

But are the stocks a smart buy?

Shares of gunmaker stocks have rallied over the past month as their stronger financial footing becomes apparent. Though their value might not be quite as attractive as it once was, investors can still find good values.

American Outdoor Brands looks exceptionally cheap, trading at only eight times the free cash it produces, while Sturm, Ruger is only marginally less so at 11 times free cash flow. Vista Outdoor's stock is even cheaper at four times free cash flow. But its decision to sell its firearms business -- coupled with a slumping ammunition division and a still-uncertain outdoor recreation business in the midst of a reorganization -- creates sufficient doubt.

It always seemed that it was just a matter of time before the gun industry made a U-turn. Now that it's apparently reached its nadir, investors might want to consider gunmaker stocks again.