Is Smith & Wesson Wasting Your Money?

Stock buybacks are generally considered a bullish signal on Wall Street. They return capital to shareholders, while declaring management's belief that its own cheap shares are its best return on investment. As long as profits remain consistent, share repurchases can even increase earnings per share, by dividing the same amount of earnings among a smaller pool of shares outstanding.

But don't forget -- a company isn't obligated to repurchase shares just because it announced its intention to do so. So don't use the announcement as a reason to buy by itself. Rather, use it as a launching pad for additional research.

Returning value
Having blasted through a $20 million share repurchase program it had just announced on Dec. 6, gunmaker Smith & Wesson added another $15 million buyback plan in an effort to continue returning value to shareholders. With its stock losing about a quarter of its value in the wake of the Sandy Hook school shooting, it believes its shares are significantly undervalued. I have to agree.

Sure, there's a lot more talk about gun control, and Vice President Biden hinted that President Obama may use executive orders to achieve his goals, but there's definitely no consensus that the public actually wants stricter gun laws, and if attendance at gun shows and reports from firearms dealers are any indication, people are loading up their arsenals to protect themselves.

Playing defense
Many gun owners have been suspicious of Obama's intentions ever since he was first elected, and with the tragic shooting last month so soon after his re-election, when he no longer had to try to woo voters, the mood has not improved. According to FBI statistics, the number of background checks done for firearm purchases nearly doubled in November and December from the year-ago period.

Gun sales have been strong for some time now, partly as a result of the presidential elections, but also out of fear of rising crime rates. Indeed, Sturm, Ruger faced a period where it was unable to keep up with demand because it was so strong. Concealed-carry permits are also rising.

Although the gun industry is obviously the most prominent business in the crosshairs of politicians, the video-game and entertainment industries are also getting a dose of criticism for the violence they routinely portray. Activision Blizzard , Electronic Arts , and other game makers are targeted for portrayals of violence in popular first-person shooter games such as Call of Duty and Medal of Honor, while Comcast , Time Warner , CBS , and the other networks are criticized for their cavalier attitude toward murder and mayhem. After all, exploring the "human side" of a serial killer, as Dexter does, or setting up women for rape and murder week after week on Criminal Minds, has even brought out harsh critiques from the actors themselves.

Voluntary limits to sales
But guns, obviously, are the main target of those who see this as a pivotal moment in their campaign to crack down on gun ownership. When major gun sellers such as Wal-Mart voluntarily limit the sale of guns in stores in and around Newtown, Conn., you understand they're respecting the sensitivities of the victims' families. The decision to do the same at Dick's Sporting Goods on a national level, though, is seen more as caving in to the changing winds of public relations.

But it's likely to backfire on them, as it did when Wal-Mart stopped selling guns several years ago and witnessed a drop in overall sales. There was a lot more to it than just the gun angle, but sales certainly surged after it reintroduced guns at almost half of its stores a few years later. Buyers could always turn to Cabela's and other sellers and avoid having to go to Dick's altogether.

On target
At just nine times earnings and estimates, Smith & Wesson looks cheap, particularly as sales and backlog are booming at the moment. Without a real national consensus that more needs to done on guns other than perhaps enforce the many laws that are already on the books, S&W should continue shooting out the lights. Its enterprise value may be elevated at 18 times the free cash flow it produces, but with demand at all-time highs, it's likely it will grow into its valuation.

I see a solid next quarter ahead, but let me know in the comments section below whether you agree Smith & Wesson can defend itself against attempts to harm its business.

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The article Is Smith & Wesson Wasting Your Money? originally appeared on Fool.com.

Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and owns shares of Activision Blizzard, Dick's Sporting Goods, Microsoft, and Sturm, Ruger. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

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