Why Is the Market Ignoring the Fact That Gun Sales Are Booming?

Just because gun sales aren't booming at the same rate they were during the biggest year ever for firearms manufacturers, that doesn't mean they're not still rising. Yet the way the market responded to the FBI release of April gun buyer background-check data, you'd think we were in the midst of a major downturn.

The fact is, gun sales are surging, and when American Outdoor Brands (NASDAQ: AOBC) and Sturm, Ruger (NYSE: RGR) report earnings for the current quarter, it's likely Wall Street will respond with shock and surprise at how strong demand was.

Image source: Getty Images.

Boom times

The federal law-enforcement agency says it processed more than 2 million background checks through its National Instant Criminal Background Check System in April, some 16% lower than it did in March and down 5% from the year-ago period. At first glance, it seems reasonable to say the market was right to drop the stocks of Smith & Wesson's owner and Ruger. But taking superficial readings leads to the wrong conclusion, as it has in this instance.

As noted, 2016 was the biggest year for gun sales. The FBI processed more than 27.5 million background checks last year, 19% more than it had the year before and more than double the number it did a decade ago.

American Outdoor's fiscal third quarter, which ended Jan. 31, showed that firearms sales over the nine-month period jumped 30% from the prior year, with 25% more handguns shipped and 68% more rifles. Similarly, Ruger, whose fiscal year runs parallel to the calendar year, reported that firearms revenues rose 21% for the year to $658 million. Even ammunition makers such as Olin (NYSE: OLN), which manufactures the Winchester brand, saw revenue rise last year, albeit at a lower 3% rate, though that was mostly due to lower sales to the military and to industrial customers.

Gun sales (and, to a lesser extent, ammo sales) were mostly driven by political considerations, as many gun owners and enthusiasts anticipated a different outcome in the presidential elections last November. When Donald Trump came out on top, the threat of new gun control legislation was largely removed from the table, and the need to buy a gun right away before new laws were enacted waned.

But it didn't eliminate the demand for new guns; it just deferred them. Gun control doesn't really affect demand, only the timing of the purchase, typically pulling forward sales that would occur anyway. And that's what we're seeing with the FBI's numbers so far in 2017.

A different benchmark

If you compare April's FBI background check numbers with those of 2015, what you see is that background checks are running 20% above that level, and if you check back on every month so far this year, you see the same thing. Over the first four months of 2017, the FBI has processed over 8.7 million background investigations of potential gun buyers, 19% more than the 7.3 million it conducted two years ago.

Data source: FBI. Chart by author.

The trend of gun buying still remains ever higher, and though it's not as high as the biggest year ever for the industry, it shouldn't be expected to maintain that pace. Last year should rightly be seen as an outlier and not the benchmark.

A better ruler to measure the health of the industry might be to take the two-year average of FBI NICS investigations, and there we see that so far this year, gun buyer demand is running about 8% higher than it was last year.

Data source: FBI. Chart by author.

All of this says the market's knocking down the stocks of American Outdoor Brands and Sturm, Ruger makes them very attractively priced at these levels. Eventually the market will come to its senses and realize that it's been looking at the data all wrong, at which time the gunmakers will be set for a major upgrade.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.