Better Buy: Smith & Wesson Holding Corp. or Taser International?

By Markets Fool.com

Smith & Wesson (NASDAQ: SWHC) and Taser International (NASDAQ: TASR) have both made a lot of headlines lately. Smith & Wesson saw its stock rally after mass shootings sparked fears of tighter gun regulations. Taser experienced higher demand for its Axon body cams following a rash of police shootings of unarmed individuals across the country.

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Image source: Getty Images.

Smith & Wesson rallied 28% since the beginning of the year, while Taser soared 51%. Both stocks easily outperformed the S&P 500's 7% gain. But is either self-defense stock still a buy at current prices? Let's compare their growth, profitability, and valuations to find out.

What do Smith & Wesson and Taser sell?

Smith & Wesson mostly sold handguns, rifles, and ammunition in the past. But to diversify its business over the past two years, it acquired accessories makerBattenfield Technologies, knife maker Taylor Brands, andCrimson Trace, a maker of tactical lights and laser sights. Those purchases turned its accessories division into the company's fastest growing unit in2015.

Taser launched its namesake electric weapons in 1993, and introduced its body cameras in 2008. It also runs Evidence.com, a cloud-based digital evidence management platform which allows law enforcement agencies to store, manage, and share video data from its cameras. According to a 12-month study released bythe Rialto Police Department in 2013, Axon cameras reduced complaints against officers by 88% and there was a 60% reduction in "use of force" incidents. That's probably why Taser's Axon business is growing much faster than its electric weapon one.

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How fast are Smith & Wesson and Taser growing?

Smith & Wesson's sales rose 40% annually to $207 million last quarter, compared to 22% growth in the previous quarter and 12% growth a year ago. Sales of firearms rose 48% to $192.4 million, but sales of Outdoor Products and Accessories fell 17% to $14.6 million. The company attributes that slowdown to higher prices reducing overall sales but improving margins.

The number of NICS background checks for firearm purchases, a key metric of the gun industry's strength, hasrisen annually for 16 consecutive months. Analysts expect Smith & Wesson's sales to rise 27% this year but just5% next year, due to the news-driven cyclical nature of gun sales.

Taser's sales rose 26% annually to $58.8 million last quarter, compared to 24% growth in the previous quarter and 26% growth a year ago. Sales of its Taser weapons rose 20% to $45.5 million, while sales of its Axon devices soared 49% to $13.2 million. At the end of the quarter, 34 major city law enforcement agencies had purchased Axon cameras of its digital evidence management software. Analysts expect Taser's sales to rise 21% this year and 19% next year, which gives it more stable annual growth than Smith & Wesson.

Image source: Taser International.

How profitable are Smith & Wesson and Taser?

Smith & Wesson's gross margin rose 250 basis points annually to 42.3% last quarter, thanks to higher production volumes, inventory adjustments in the firearms segment, and the aforementioned higher margins from its outdoor products and accessories. GAAP earnings rose 119% to $0.57 per share, and non-GAAP earnings rose 94% to $0.62 per share. Analysts expect the company's non-GAAP earnings to rise 36% this year but dip 4% next year, due to the expected decline in year-over-year sales growth.

Taser's gross margin fell 300 basis points annually to 63% last quarter, due to higher sales of Axon's lower-margin devices. Taser weapons had a gross margin of 68% last quarter, but the Axon business had a gross margin of 47%. The expansion of its international team andpursuit of military accounts is also expected to apply additional pressure to its margins.

That's why Taser's net earnings fell 36% to $0.07 per share last quarter. Analysts expect that pressure to cause itsearnings to fall 25% this year before possibly rebounding 63% next year as these growing pains subside.

The valuations and the verdict

Smith & Wesson currently trades at 14 times earnings, while Taser has a much higher P/E of 104. This means that Smith & Wesson's stock is undervalued relative to the industry of 19 for defense product makers, while Taser looks extremely overvalued.

Smith & Wesson is expected to post an average of 15% annual earnings growth over the next five years. This gives it a 5-year PEG ratio of 0.75, suggesting that it is undervalued relative to its growth potential. Taser is expected to grow its earnings by 30% over the next five years, but that gives it a much higher PEG ratio of 3.3.

Based on the valuations, Smith & Wesson looks like a better buy than Taser. However, I'd still avoid the stock because its future sales could be heavily impacted by new regulations and panic-fueled sales. Therefore, I believe that Taser is a better long-term play, but only after the stock's price and valuations cool off to more reasonable levels.

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Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Taser International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.