You're Thinking About Gun Industry Sales All Wrong

Gunmakers got a boost when it was revealed the Trump administration was considering making it easier to sell guns overseas. With the U.S. firearms industry in a funk since the presidential election, a new avenue of growth would be welcome news for manufacturers like American Outdoor Brands (NASDAQ: AOBC) and Sturm, Ruger (NYSE: RGR). Anything that could get inventory moving again would be a benefit.

However, despite the news you hear about how low the gun market has fallen, things aren't really as bad as they seem. It's not the gunmakers that are the problem but how the market prioritizes short-term results.

Guns are shooting off target

It's already well known that FBI criminal background checks of potential gun buyers are off from last year's numbers. In 2016, the law enforcement agency processed 27.5 million applications, a new all-time record since the agency first began tracking them in the late 1990s. The number almost doubled in the last six years and nearly tripled in the past decade.

So the fact that year-to-date background checks are down 9% is a big deal. Even the adjusted data put out by the National Shooting Sports Foundation seem to indicate an industry in decline. After controlling for checks on current concealed carry permit holders and purpose code checks (such as agencies returning a firearm in their possession to an individual at the end of a case) -- tweaks that give a more accurate assessment of the market -- demand is down by almost 10%.

That's also borne out by the financial performance of the gunmakers. American Outdoor Brands reported fiscal 2018 first quarter net sales were down 38% earlier this month on a near-50% plunge in firearms sales. It shipped 33% fewer handguns and 54% less long guns.

Ruger reported a 21% drop in revenue; shotgun and ammunition maker Vista Outdoor (NYSE: VSTO) reported a 19% decline in its shooting sports division; and Winchester ammunition maker Olin (NYSE: OLN) saw sales fall 6% but only because it was able to get a boost from military contracts.

It all lends credence to the argument the gun industry is hurting, but is that the whole story?

A better way to count

Comparing current year data to the biggest year in the firearms industry's history is going to give you a skewed picture. It would be like comparing the recession of 2007 to 2009 to the Great Depression and saying things weren't so bad.

Instead, we can look at the two-year numbers to assess the health of the industry. Many companies actually do this when providing their earnings, because it smooths out bumps and one-off events that can occur during a single year.

When we do that with the background check numbers, regardless of whether it's the raw data from the FBI or the adjusted numbers from the NSSF, we get a completely different picture:

Looking at the FBI's data, we see the year-to-date background checks from 2015 to 2016 averaged almost 16 million investigations, but from 2016 to 2017, the average is over 17 million.

Similarly, NSSF figures show there were on average over 9.2 million background checks of gun buyers from January to August in 2016 and 2017, but less than 9 million in the prior two year period.

A hair trigger for growth

What this means is that gun demand has not weakened to historical lows -- it's just running behind the biggest year ever for the industry when presidential politics, concern for personal safety, and fear of greater gun control initiatives fueled incredible growth. Even comparing 2017 to 2015, we see background checks from both data sets are still trending higher.

That indicates demand for guns remains on the same upward trajectory it's always been on, and the industry remains healthy. It also suggests the beaten down valuations of gun company stocks, despite the small boost they got from potential international expansion, makes them especially attractive.

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