Mr. Market greeted earnings from firearms maker Smith & Wesson (Nasdaq: SWHC) by shooting over 12% out of the stock price the day following the report.

At first glance, the report isn't bad. Analysts were expecting only a penny a share in earnings and Smith & Wesson smoked that target with four cents, two after nonrecurring charges are backed out. But that's a drop from the nickel per share in the year-ago quarter.

A decrease in firearms sales was offset by an increase in security systems revenue driven by last year's acquisition of Universal Safety Response. Even with the efforts to expand into new business areas, firearms sales dominate Smith & Wesson revenues, accounting for over 80% of sales last quarter.

A useful indicator of firearms sales is the number of monthly background checks published by the FBI. These checks aren't a direct count of firearm sales, but nonetheless provide a good indicator. Last year background checks were at an all-time high, leading to brisk business for Smith & Wesson and competitor Sturm, Ruger (NYSE: RGR). However, for the last four months, background checks have been decreasing compared to the previous year.

Smith & Wesson and Ruger have both missed much of the market run over the past year with both companies well off 52-week highs. A forward P/E higher than the past year shows both companies are expected to have earnings fall off

Company

P/E (TTM)

P/E
(2011 est.)

52-Week Range

Recent Price

Smith & Wesson

6.5

10.9

$3.83 - $7.52

$4.14

Sturm, Ruger

8.7

14.4

$9.61 - $15.20

$12.36

Source: Motley Fool stock quotes. TTM = trailing 12 months.

Investors looking to add firearms to their portfolio don't have many choices. Smith & Wesson and Ruger are the only publicly traded U.S. firearms makers. Ammunition manufacturers Olin (NYSE: OLN) and Alliant Techsystems (NYSE: ATK) are also linked to firearms, but both have extensive business operations beyond filling ammo magazines. Retailer Cabela's (NYSE: CAB) provides some exposure to pistols, rifles, and shotguns, but firearms are only a piece of its business.

Smith & Wesson looks like a value stock with its below average P/E and price near the 52-week low. But the dropping trajectory in its main business line justifies the low price. This Fool would like to see gun sales steady and some improvements in the new security business before pulling the trigger.

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