Over the past year, perceived rises in crime rates, coupled with the fear of further gun restrictions, sparked a rally with firearms manufacturers Sturm, Ruger (NYSE: RGR) and Smith & Wesson (NASDAQ: SWHC). At this point, Sturm, Ruger possesses the most upside potential. Here's why.

RGR data by YCharts

1.) Lower P/E ratio. Sturm, Ruger's P/E of 16 indicates greater upside potential than Smith & Wesson's 20 (see chart below).

RGR P/E Ratio TTM data by YCharts

2.) Higher Margins. In the chart below, Sturm, Ruger's gross margin (37.75%) eclipses Smith & Wesson's by 3 basis points (37.72%). Sturm, Ruger's superior margins stem from the fact that Smith & Wesson divested their security division on Oct. 5, 2011 creating a loss on discontinued operations, putting a dent in their margins.

RGR Gross Profit Margin data by YCharts

Sturm, Ruger's operating margins (21.10%) sit 561 basis points above Smith & Wesson's (15.49%) (Chart below).

RGR Operating Margin TTM data by YCharts

Sturm, Ruger's net margin (15.07%) exceeds Smith & Wesson's by 199 basis points (13.08%)(see chart below).

RGR Profit Margin data by YCharts

3.) Lower swings in earnings and cash flow. In the charts below, Sturm, Ruger maintained consistent positive net income over the past 10 years. Sturm, Ruger's free cash flow dipped in the negative during the recession and around 2005. Smith & Wesson's free cash flow stayed in the negative prior to 2008.

RGR Net Income TTM data by YCharts


RGR Free Cash Flow TTM data by YCharts

4.) Plenty of Cash. Sturm, Ruger's cash to stockholder's equity clocks in at 59% of equity placing the company in a sweet position to design new products and pay dividends. Year to date, 38% of Sturm, Ruger's sales came from new products such as the Ruger American Rifle, SR22 pistol, 10/22 Takedown rifle, and 22/45 Lite pistol. Smith & Wesson's cash to stockholder's equity stands at 46%.

5.) Variable Dividend Policy. Sturm, Ruger pays a dividend based on net income. Most recently, its board of directors decided to increase the payout ratio to 40% of net income. Year to date, a relatively low 41% of Sturm, Ruger's free cash flow was paid out in dividends.

6.) Higher Return on Equity.  A higher return on equity means more efficient use of shareholders' capital. Sturm, Ruger's return on equity (38.26%) far exceeds Smith & Wesson's (30.75%), as shown in the next chart.

RGR Return on Equity data by YCharts

7.)    Less Leverage. Sturm, Ruger’s total debt-to-equity ratio hovers at 42%, way below my personal threshold of 85%. They have no long-term interest-bearing debt (chart below). Smith & Wesson’s total debt-to-equity and long-term debt-to-equity ratios trail Sturm, Ruger’s at 107% and 34%, respectively.

RGR Debt to Equity Ratio data by YCharts

8.) Focus. Some 67% of Sturm, Ruger's sales comprise pistols and revolvers. Only 2% of Sturm, Ruger's sales come from non-firearm sources. The difference comes from rifles.

Handguns make up 57% of Smith & Wesson's sales, with 9% of 2011 sales coming from parts, accessories and non-firearm sales such as handcuffs and security.

9.) Political and Social Catalysts. Concerns that the Obama administration will restrict future gun sales, combined with adverse crime trends, will continue to propel gun and ammo sales higher for Sturm, Ruger and Smith & Wesson. These concerns persist even though no new anti-gun legislation has been mentioned.

According to the FBI Preliminary Annual Uniform Crime Report, burglary showed an increase of 0.3% in 2011. If this trend continues, people may purchase more guns in order to feel safe. A word of caution: If a gun-friendlier regime is elected, the panic buying of firearms may subside at least for a while.

Sturm, Ruger's noteworthy upside potential -- including a lower P/E ratio, superior margins, and steady growth -- should warrant any value investor's attention. Sturm, Ruger's excellent cash position and variable dividend policy show discipline with cash management. The company also knows how to better utilize its capital, has less debt, and shows focus in mainly manufacturing and selling pistols and revolvers. Also, while this is one catalyst I hope decreases, an uptick in burglary or other crimes would likely fuel further rises in handgun sales. Sturm, Ruger definitely deserves a place on your watch list.