Did Smith & Wesson make a big mistake chasing the outdoor market?

It might have seemed like a good idea at the time to change the Smith & Wesson name to American Outdoor Brands(NASDAQ: AOBC) as a way of signifying the new direction the company was taking, but the decision to go after the rugged outdoor market might not have been fully informed.

Despite the slowdown in firearms sales this year, it's industry pure-play Sturm, Ruger(NYSE: RGR) that looks like the solid investment at this point, while those that diverted their attention to other markets are facing headwinds.

A rose by any other name

There was logic behind abandoning Smith & Wesson as the corporate name, even if it seemed foolhardy to take down such a well-known brand from the marquee. American Outdoor was seeking to diversify its revenue streams away from firearms, and the outdoors market was considerably larger and offered greater growth prospects.

Ever since acquiring Battenfeld Technologies in 2014, the firearms manufacturer sought to downplay the role guns had in its business while pointing out the outdoors market was orders of magnitude larger.

Gun sales always have their ebb and flow. Particularly when events cast a shadow on the industry and the potential for stricter gun laws seems greater, gun sales surge and then fall back as the crisis fades. Entering a new, parallel market that both supports its primary firearms business, but can also grow independently of it, gave American Outdoor the opportunity to smooth out many of the hills and valleys. 

RELATED: Check out the U.S. states with the toughest gun laws:

26 PHOTOS
States with the toughest gun laws
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States with the toughest gun laws

24. Indiana

Grade: D-

Source: gunlawscorecard.org

(Photo credit should read KAREN BLEIER/AFP/Getty Images)

T-23. North Carolina

Grade: D-

Source: gunlawscorecard.org

(Chuck Liddy/Raleigh News & Observer/MCT via Getty Images)

T-23. New Hampshire

Grade: D

Source: gunlawscorecard.org

(Photo credit should read DOMINICK REUTER/AFP/Getty Images)

T-21. Virginia

Grade: D

Source: gunlawscorecard.org

(Photo by Jabin Botsford/The Washington Post via Getty Images)

T-21. Ohio

Grade: D

Source: gunlawscorecard.org

(Photo by Spencer Platt/Getty Images)

20. Nebraska

Grade: D

Source: gunlawscorecard.org

(Photo via Getty Images)

19. Wisconsin

Grade: C-

Source: gunlawscorecard.org

(Photo by John Gress/Corbis via Getty Images)

18. Nevada

Grade: C-

Source: gunlawscorecard.org

(Photo via Getty Images)

T-16. Michigan

Grade: C

Source: gunlawscorecard.org

(Photo via Getty Images)

T-16. Iowa

Grade: C

Source: gunlawscorecard.org

(Photo by Luke Sharrett/Bloomberg via Getty Images)

15. Oregon

Grade: C

Source: gunlawscorecard.org

(Photo via REUTERS/Lucy Nicholson)

14. Colorado

Grade: C

Source: gunlawscorecard.org

(Photo via REUTERS/Rick Wilking/File Photo)

13. Pennsylvania

Grade: C

Source: gunlawscorecard.org

(Photo credit should read DOMINICK REUTER/AFP/Getty Images)

12. Minnesota

Grade: C+

Source: gunlawscorecard.org

(Photo via AOL)

11. Delaware

Grade: B

Source: gunlawscorecard.org

(Photo via Getty Images)

10. Washington

Grade: B

Source: gunlawscorecard.org

(Photo via Getty Images)

9. Rhode Island

Grade: B+

Source: gunlawscorecard.org

(Photo by Kenneth C. Zirkel via Getty Images)

8. Illinois

Grade: B+

Source: gunlawscorecard.org

(Photo via REUTERS/Jim Young)

7. Hawaii

Grade: A-

Source: gunlawscorecard.org

(Photo via Getty Images)

T-5. New York

Grade: A-

Source: gunlawscorecard.org

(Photo via REUTERS/Shannon Stapleton)

T-5. Maryland

Grade: A-

Source: gunlawscorecard.org

(Photo credit BRENDAN SMIALOWSKI/AFP/Getty Images)

4. Massachusetts

Grade: A-

Source: gunlawscorecard.org

(Photo via Getty Images)

3. New Jersey

Grade: A-

Source: gunlawscorecard.org

(Photo by Mark Makela for The Washington Post via Getty Images)

2. Connecticut

Grade: A-

Source: gunlawscorecard.org

(Photo via Getty Images)

1. California

Grade: A

Source: gunlawscorecard.org

(Photo credit MARK RALSTON/AFP/Getty Images)

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Timing is everything

Unfortunately, it chose to pursue this new course just as the sporting goods market went into a tailspin. Outlets like Eastern Mountain Sports, Sports Chalet, City Sports, and of course Sports Authority all went bankrupt. Outdoors superstore Cabela's saw its fortunes take a turn for the worse and it had to be rescued with a buyout by Bass Pro Shops. Even Dick's Sporting Goods(NYSE: DKS) has been struggling.

The impact has been especially hard on Vista Outdoor(NYSE: VSTO), which like American Outdoor, is positioned in both the outdoors and firearms markets. Not only does it have sporting goods brands like Bushnell, Tasco, and Camelbak, but it owns Federal Premium ammunition and makes shotguns and rifles through its Savage Arms division. After another earnings disaster last month, the company is undergoing a major overhaul.

Vista Outdoor stock has lost over 60% of its value in 2017, but it continues to be pressured by additional bankruptcies and consolidation that reduces the number of outlets it's able to sell into.

A shot in the dark

It's a similar problem for American Outdoor Brands, whose stock is down 33% this year. Firearm sales were nearly cut in half this quarter, and gross margin took a hit as high inventory levels at firearms dealers put pressure on sales and profits. The big Black Friday sales surge will only partially ameliorate those problems because, despite potentially lowering inventory levels, it also pulled sales forward, meaning gun sales that would have been made later in 2018 are being realized now.

While organic growth was flat year over year in American Outdoor's outdoor product segment, profits were hurt due to the lower margins such merchandise realizes.

There are a lot of moving parts for American Outdoor at the moment because of all the acquisitions it made over the past year or so, but in comparison to Sturm, Ruger, it appears to be the weaker investment because of the decisions it made.

Sure, firearms sales at Ruger were down 35%, but gross margin only narrowed to 28.8% from 31.1% last year because it largely does not participate in the heavy discounting practiced by others.

Certainly, the firearms industry is in a period of flux, and it's going to take some time for it to reach a new normal, but the outdoors market, despite the larger growth potential it offers, looks to be in an even worse state. It could be that American Outdoor Brands chose the exact wrong time to enter, while Sturm, Ruger will come out ahead because it remained true to its roots.

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.

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