What: Shares of Smith & Wesson Holding Corp. (SWBI -1.50%) are down more than 16% at 12:07 p.m. ET on April 4, following several analyst downgrades announced this morning.
So what: Analysts with BB&T Capital Markets, Cowen & Co., and CL King all issued notes downgrading Smith & Wesson stock, based on some relatively short-term and highly cyclical news. March NICS data showed background checks were up 25% from last year, but down sequentially. BB&T also said in a research note that its downgrade to "hold" from "buy" was also based on the stock's valuation, which had increased sharply since January.
Now what: Let's start with analyst ratings. Investors would do well to know that, in the aggregate, analyst ratings and "buy" and "sell" recommendations aren't very accurate predictors of stock performance. In fact, they are no better than flipping a coin. In the short term, there is often -- as we see today with Smith & Wesson -- a short-term pop or drop following an upgrade or downgrade, but over the next weeks, months, or years, there's little reason to count on Wall Street analyst ratings to inform your investing decisions, simply because they're bad predictors of stock performance.
Second, firearm background checks have been on an upward tear for years, so it's probably not worth getting too caught up in a single monthly sequential decline. At the same time, this is a presidential election year, so you can bet that -- at least this has been the case in the past decade -- not only will firearm stocks be volatile, but background check activity could also be very up and down, depending on who's the leading candidate for the White House job.
Last, while there is certainly some potential political risk, particularly if a more progressive justice ends up replacing Antonin Scalia on the U.S. Supreme Court or if Democrats manage to take back part or all of Congress as well as win the presidency, it's probably much smaller than most people on either side of the political spectrum are willing to admit.
The bigger concern for Smith & Wesson is its ability to continue to grow profitability and largely its planned further expansion into sporting apparel and accessories, which will be driven primarily by acquisition. On the surface, it's probably a smart idea, but the reality is, growth by acquisition -- especially into a secondary business -- is rarely as successful as a company expects it to be.
And understanding the company's expansion plans and keeping an eye on the return its investments in growth generate matter a lot more than how sell-side analysts rate the stock.