Shares of gun makers have tanked in the wake of the horrific shooting at Sandy Hook Elementary School. For example, shares of gun maker Sturm, Ruger & Co. (NYSE: RGR) are down 15 percent and shares of rival gun manufacturer Smith & Wesson Holding Corp. (NASDAQ: SWHC) are down 18 percent since last Thursday, the day before the shooting.
The reason offered by the media for the decline in share prices of gun makers is fear over new gun legislation, which could impact sales for the companies. Additionally, there is talk of large shareholders dumping shares of the companies out of moral (or as a public relations stunt). However, most of these arguments miss the basic economic reasons for the stock decline. We will leave the political realm and delve into the economics of the companies.
Since Barack Obama was elected in 2008, shares of both companies mentioned have soared. After Obama’s re-election, the shares of the gun makers shot up once again. Sturm, Ruger & Co. has had a particularly impressive run, with the stock up 600 percent since November 2008.
The gun makers reported record sales as Americans who feared more gun restrictions bought firearms in droves. In the first quarter of 2008, Strum, Ruger & Co. had $42.51 million in sales, which reached $118.15 million in the latest quarter. The company reported earnings per share of $0.07 in the first quarter of 2008 compared with earnings of $0.88 per share in the third quarter of 2012, a 1250 time’s increase.
These trends were clearly unsustainable. There are only so many guns that people can buy, and the reason for sales were fear, not expansion, such as a company like Coca-Cola expanding overseas. The company had a high valuation as well and it was only a matter of time until investors would realize that sales would stagnant or decrease.
I am not only talking with hindsight. I noticed this trend several months ago, as shares of gun companies soared every time Obama took the lead in the 2012 election campaign. In my website’s premium section, I recommended shorting shares of Strum, Ruger & Co. back in late September.
The real reason for the drop in stock price is fundamentals, not because of political events. The tragedy in Sandy Hook was only the catalyst for the recent drop, but not the cause of the drop.
A good example would be tech stocks in the late 1999s and early 2000. The stocks had absurd valuations and many eventually crashed hard. However, what caused the drop (the catalyst) was not related to those companies. Tech stocks started to decline following a ruling that declared Microsoft a monopoly.
Investors can learn an important lesson from this. The media may be right about the catalyst, but the real reasons for stock drops (or increases) are usually much more subtle and complex.
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