Shares of firearms and ammunition makers are rising Monday following the tragic shooting this weekend in Orlando.
It's a conventional one-off in the equities market - one of the more predictable ones at that. Tragic gun incidents spike fears of the onset of gun control regulation. Meanwhile, citizens who might have otherwise been resistant explore handgun purchases for personal protection.
While Monday's action follows a familiar pattern in the equities market, this one isn't even comparable to the gains that both stocks experienced following the December assault in San Bernadino, Calif., and in the terrorist attacks in Paris. This isn't to suggest that investors have somehow become more callous about tragedies - though there's obviously some traders who game the response to those incidents - but are, in fact, aware of a persistent pattern.
In fact, gun sales figure to increase once again following the tragedy. Following the San Bernadino terrorist incident, background checks on gun applicants processed by the federal government experienced the conventional spike: from 2.2 million in November to 3.3 million in December. It's a pattern that's been established before: following the assault at the elementary school in Sandy Hook in December 2014, background check applications jumped to 2.3 million in December from 1.8 million the preceding month.
Granted, the government data--collected as the National Instant Criminal Background Check System--are imprecise proxies for gun sales. Even the applicants who pass the NICS check don't always follow through to actually purchase a firearm. Some purchase more than one.
But the NICS data does, to some extent, act as a governor on the performance of the stocks of weapons makers. Both Smith & Wesson and Sturm Ruger took hits last month after NICS data showed a 13% decline in May versus April. Smith & Wesson fell 7%, Sturm Ruger declined 5% the day of the data release. The declines don't compare with the quick spikes such as the market is seeing Monday. But the short term gains typically prove to be just that--short term in nature.
What's more, short interest in both stocks - good indicators that some traders are betting on share price declines - spiked. Short interest for Smith & Wesson climbed 370% versus January levels in May.
What typically happens is that tragedies do provide short-lived spikes in firearms sales. Assuming tradition prevails, the market floods with product, and sales plateau when tempers cool. Firearms products end up becoming something approaching a commodity. Gun enthusiasts may evince a preference for Smith & Wesson over Sturm Ruger products, the way a generation of car buffs used to argue about Chevies versus Fords. Nevertherless, even Sturm Ruger management has said that the firearms marketplace "is crowded with product," which hurts pricing, and, in turn, margins.
Even in periods of robust firearms sales, expectations can run ahead of reality. For its 2016 first quarter, for instance, Sturm & Ruger reported a 49% jump in sales; revenues climbed 26%. The revenue number, nevertheless, fell short of estimates.
The next data point to watch comes June 16, when Smith & Wesson reports its fiscal fourth quarter results.
From a fundamental perspective, the investment argument of Smith & Wesson versus Sturm Ruger is mixed: Sturm & Ruger has a tendency to get pricey, with a P/E that can get into the 30s, while Smith & Wesson comes in at 21 times, just a little north of the market average. However, Sturm has more of an investor-friendly reputation - it yields 3%, spends about a quarter of its free cash flow on dividends, and a third on share repurchases. Smith & Wesson has no tradition of returning capital to shareholders.
Investors looking for firearms plays might take a look at Vista Outdoor Sales (VSTO - Get Report) . The company was carved out of Alliant Techsystems before that company's merger with Orbital Sciences. It provides ammunition for firearms - about 40% of the ammo market - as well as outdoor accessories. Vista Outdoor has evidenced an appetite for rollups, having acquired the Action Sports division of BRG Sports earlier this year.
There's also the issue of what's conventionally dubbed "reputational risk" associated with firearms companies that essentially provide the weapons used in terrorist attacks and hate crimes. Shares of the British security firm G4S lost more than 8% in trading in London Monday after it was revealed that the suspected Orlando nightclub killer was employed by the firm. Shares of the stock have declined 34% in the past 12 months on the London exchange.
In the long run, there's a higher risk of volatility in the stocks of handgun makers than there is for, say, more conventional consumer products. There's the daily fluctuations in market value. Today's movements are to the upside, something that nevertheless reflects the inherent volatility of these shares. Smith & Wesson has doubled since its lows last August, but shares have dropped 29% since March. Sturm Ruger has climbed 62% off its lows for the year, but shares are down 26% in three months. Given the volatility in these stocks - especially the exposure to daily gyrations - it could be argued that handgun makers are better trades than investments.