Recommendation: Buy Sturm, Ruger (NYSE:RGR) for $53 or less with an initial profit target of $58 per share before fourth-quarter earnings season.
Options Alternative: Buy to open RGR’s April 2013 50 Calls for $5.50 per share or less.
Will democrats use President Obama’s second term to implement gun-control legislation? If so, is this a bad thing for gun manufacturers?
We think it’s unlikely that gun control will be a high governmental priority in the short term. However, regardless of whether we’re right, this election obviously sustained the fear of gun-control legislation, which should give gun company stock prices another significant boost.
On Wednesday, we noticed most stocks were selling off, with a few interesting exceptions — gun companies like Sturm, Ruger and Smith & Wesson (NASDAQ:SWHC) were up significantly. The pair made another climb higher Thursday.
In the chart of SWHC below, notice how the bounce was in line with technical support. In other words, this is not just a one-day phenomenon. Smith & Wesson dropped 93% during the last Republican administration and has risen 400% off those lows since Obama took office in 2009.
What should investors and gun owners think about the potential for gun profits in light of this data?
Much of the rally during the past few years likely has been driven by a fear of future scarcity. If gun owners or prospective gun owners are worried that gun control will become an issue, they will be motivated to buy guns before such scarcity becomes a reality.
The specter of legal restrictions as a motivator for buyers should not be underestimated.
There might be a Democratic agenda to curtail gun rights in the future; however, investors should keep in mind just how long it takes to enact such legislation, and what other items of legislation may take precedence. For example, think back to the shootings in Aurora, Colo., earlier this year. It seemed to be an opportunity for the gun-control lobby to make a move, but they were completely rebuffed by both sides because it would have been a polarizing distraction in the middle of a difficult economy and a tight election. Thinking ahead, if Democrats need to reach some compromise with Republicans over the upcoming “fiscal cliff,” is that a good time to introduce gun control legislation?
In short: Gun control isn’t likely to be something either side wants to take on immediately. However, postponing any kind of real push for gun control continues to stretch the fear of scarcity into 2013 or 2014 at a minimum. If legislation were to start attracting attention in Congress earlier than that, it would only accelerate those fears and continue driving demand — and stock prices — higher.
RGR Historical Performance
We expect buying pressure, scarcity fears and strong financial performance to help gun-makers over the next 12 to 18 months. We recommend RGR because, unlike other players in the industry, it has produced stronger fundamentals and better earnings growth since the 2008 financial crisis — and that stronger balance sheet should give it an edge over competitors if the markets start to experience some volatility.
In its most recent quarterly report, RGR reported revenue of $118 million, which was up more than 47% in the year-ago period. Profits were 88 cents per share — a 57% increase. That kind of performance has been a rare sight this earnings season and would make any company interesting to investors.
In the next chart is our technical projection for RGR based on the depth of the recent channel.
Our initial projection is near the company’s long-term highs (achieved during a Democratic presidency) of $58 per share. The rally on Nov. 7 is just the kick-start we have been waiting for to attract new buyers. RGR beat earnings and revenue estimates on Oct. 31, which should do a lot to attract buyers before its next report in Q1 2013. RGR even could meet our profit objective before then.
It seems reasonable to expect other companies to benefit like we expect RGR to over the next 12 to 18 months. However, the pickings are slim if you want to avoid stocks that were overleveraged during the economic boom of the 2000s. We did consider an alternative investment in gun retailers like Big 5 Sporting Goods (NASDAQ:BGFV) or Dick’s Sporting Goods (NYSE:DKS), but opted for a more direct investment to avoid problems within the broader retail sector.
RGR does not have a very liquid option chain sheet, but a longer-term expiration should provide the flexibility traders need to split the bid/ask spread with a limit order.
We recommend buying to open the April 2013, 50 calls for $5.50 per share or less. This option is slightly out of the money, but we expect the move to the upside to be completed quickly and an out-of-the-money option promises a more attractive return on investment.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.