Saturday, January 23, 2016

Gun Stocks (and Bonds)

This is not what I am talking about.

In the idiot media in the last few days, are articles touting how well gun manufacturers have done and why gun stocks (stocks in companies making firearms) are a "sure thing" investment.   This is, of course, idiotic advice on three levels.

First, the best time to buy a stock that has shot up in value is before it shoots up in value (and pardon the pun).  So, the best time to buy a firearms stock would have been before Obama was elected, or at the nadir of the market in early 2009 or before one of the mass-shootings, say, in 2011.   Today, it may be too late as we will discuss in more detail below.   Timing the market is hard to do, without a working time machine.

Second, you have to buy the right stock.   Even if you (a) successfully identify the right market segment to invest in, and (b) successfully identify the correct time to invest, you still have to (c), successfully identify the correct company to invest in.   If you thought, for example, that Colt Firearms, which seems like the GM of the gun business, would have been a good bet, you would have lost everything.   Yes, in the middle of crazed gun-buying, they found some way to go bankrupt.

Third, you would have to know when to sell.   And that is the real problem with stocks that are identified by the media after they have gone up in value.   Apple, for example, wasn't talked about by the financial media when the stock was in the toilet, not so many years ago.   It was only when the company stock price went ballistic that everyone shouted "Buy Apple!" - but of course, by then, it was too late.   And the same could be true for firearms stocks.

There is such a thing as market saturation, in the smart phone business, and yes, even in the gun industry.   Paranoia about Obama "taking our guns away" only goes so far.   Once every American has an AR-15 and a closet full of ammo, eventually they will stop buying.   And once they realize that the second amendment does indeed protect the rights of law-abiding gun owners, the paranoia will dissipate as well.

So you buy the stock now based on media reports, and well, it may go nowhere.  Taking another firearms stock - Sturm, Ruger & Co. as an example, if you selectively filter the stock price for the last five years, the returns look pretty amazing:

Ruger had a gain of about 273% over the last five years.  Do you think it will increase by 273% more over the next five?

Ruger started out in 2011 trading at about $15 a share.  Today after peaking at nearly $80 a share in 2014, it has fallen back to about $56 a share.  That's a 273% gain, which looks pretty appealing compared to about a 50% gain in the overall DJIA during the same time period.

The question is, of course, can the company grow another 273% in the next five years?  Or even 50%?   In order to sustain such growth, sales have to grow exponentially.   Sales of smart phones went like gangbusters over the last decade, as people switched from older-style flip-phones, to the ubiquitous bar-of-soap brain enslaver.   But the market is slowing in 2016, as penetration reaches maximum.   As with Facebook, real growth remains overseas (which is why Zuckerberg so generously is giving away free WiFi in India - WiFi that only allows access to Facebook).

But again, every time we look at share price graphs, we have to realize that we are filtering data, based on time range, which can skew perceptions.  If we look at a longer timeline, we may see some interesting trends.

Going back to 1980, we see that the stock peaked during the Clinton years, and then fall back during the Bush years.   Could the same thing happen again?   Does this look like a stock on the way up, or a stock in a bubble?

In a way, this chart resembles the gold charts of the last 20 years.   Smaller bubbles in the past, followed by a huge rise up after 2009 or so.  And in both cases, the prices have corrected somewhat.  Note that during the Clinton years, when the fear of firearms confiscation (those Democrats keep threatening it, but never follow through!) were high, the stock price rose up - and then fell during the Bush years, as fears subsided.    Could we be seeing a similar pattern here?  After each mass-shooting, people buy guns, out of fear that new regulations or laws will be enacted, and profits (and share prices) go up.

But after a few months or years, people realize that, yes, the Second Amendment prevents the government from outright banning firearms sales.   So the idea that "the gub-ment is going to take your guns away" starts to lose currency, and sales slacken off.    Since guns basically never wear out (or rarely do) each time a gun enters the stream of commerce, the market becomes more and more saturated.

This is not to say that the stock is a bad buy either.   With a fairly reasonable P/E ratio and a not-too-bad dividend yield, the company stock is only a little overpriced, compared to other traditional manufacturing stocks.   The problem is, as Colt found out, there are few barriers to entry in the business, a lot of "new names" have sprung up over the years, and no one has a monopoly even on one design.  Throw in market saturation, and well, you could see some of these players go bankrupt (particularly the highly-leveraged ones) in the next few years, if demand slackens, which it likely will.

Colt is famous for two firearms.  First is the Colt .45 M1911, which was made in massive quantities by Colt and also many other arms manufacturers.  As the name implies, it went into service in 1911, and was an antiquated design, compared to today's more modern automatic pistols, which among other things, hold far more rounds.   So the time-honored 1911 has been supplanted by the Glock 17 and other more modern weapons, and Colt didn't seem too interested in updating their designs (which would you rather have, 7 rounds, or 17?) or going after the consumer market - concentrating instead on military sales.  

The other weapon - the AR-15, which originally was designed by Armalite, but was bought by Colt.   AR-15 is now a generic term to identify a number of assault-type rifles using the same basic architecture.  And today, it is one of the hottest selling weapons in the US.   When I was a kid, you simply couldn't buy military-style weaponry like this.  Today, it is on the shelf at every gun store.

Again, you would think Colt would be printing money with this design, given its popularity with gun owners.   However, once again, there are few barriers to entry in the business, and other companies - most with names you've never heard of - have built similar weapons, often of better quality and with design improvements, and have far outsold Colt in the civilian market.

NOTE:  A reader points out that Colt was, prior to bankruptcy, privately owned.   Even though a company goes private, you can still participate in it, through bonds.  For example, Dell went private, but I bought some of their corporate debt, which has done well - better than my purchase of Yum! brands corporate debt (you stoners - go out and eat more tacos!).   And apparently, the problem with Colt was, there was an awful lot of corporate debt!   Even though a company is in a "hot" market, they can still screw things up royally, as is the case with Colt.

I am sure a gun enthusiast could point out more nuanced differences.  The point is, with little in the way of intellectual property or other barriers to entry, new manufacturers can (and have) enter the field at any time when it seems sales are going up, and steal away market share from mainstream companies.   These same johnny-come-latelies are usually the first to fold when the market calms down.   It is not dissimilar to the marginally operated oil businesses going bankrupt in the Bakken right now.

And then there are the real threats of regulation in the marketplace - although I do think these are more of a long shot (again, no pun intended).   While it is unlikely the government could "take away your guns" or "outlaw gun sales" it is possible that certain gun designs could be made harder to get, or be outlawed for the civilian market.   For example, in the past, so-called "open-bolt" semi-automatic machine pistols were outlawed, as they could be easily converted to full-auto.  The MAC-10 is one example of such a design, and the company making it eventually went bankrupt as a result.

So today's hot "assault rifle" manufacturer, could be tomorrow's "out of business" manufacturer if such a weapons ban were in fact enacted (it was tried in the past, with mixed results).   Either way, you have the prospect of a diminished market, it doesn't matter if the gun control people win or lose.   Market saturation eventually kicks in, if it is not already here.

(By the way, no flames from the "there is no such thing as an assault rifle" people.   Just like the "there's no such thing as a Palestinian" people, they are trying to control the debate by controlling the terms of the debate.   Like pornography, you know an assault or "tactical" rifle when you see it.   You're fooling no one with these semantic arguments.  Maybe it is hard to define from a legal point of view, but we both know exactly what the term means).

Now, for those of you who think emotionally about the issues relating to firearms (for or against) you will both undoubtedly miss the point.   From an economic standpoint, it doesn't matter if you think you have the right to own a Howitzer (you don't) or that anything other than a BB gun should be outlawed (that can't happen either).  The issues is the same old thing - supply and demand, market saturation, and so forth.  You know - economics.

But the ultimate deal is this, though:   If the financial media is talking about a stock after it has gone up in value, chances are, it is a shitty time to buy that stock, as it has nowhere else to go.

Stock-picking is for chumps, and I know this from experience.    Individual investors simply don't have the knowledge and market research to properly be able to (a) identify market segments to invest in, (b) properly time those investments, and (c) know which stock in that market segment to buy.

And if you doubt this, ask the guy who bought Colt stock a few years back, convinced he was going to "hit it big".   Hey, gun stocks - a sure thing, right?


Buying gun stocks is the same as the 3-D printing deal.   Folks like Motley Fool are hyping 3-D printing as "the next big thing!" but the same problems occur.  Which 3-D printing company do you buy?  Because some are successful and some go out of business, and most of these printers are being made cheaply in China.

Gun stocks (or bonds) are the same deal.  Which do you buy?  Because even though the market is booming, not all companies will thrive, as Colt shows.

Basically, when the media hypes a stock or an area of investment it is too late to buy in.

Second, as I predicted, a lot of folks cannot separate a logical analysis of market conditions from emotional thinking about firearms (whether you are pro or con).   I received e-mails from people who thought that since I believed that gun stocks were not a good investment, that I was "anti-gun".   Others, who are "anti-gun" chastise me for even thinking about investing in the "merchants of death".

People are fucking morons, aren't they?  Emotional thinking will never move you forward in life, but sadly, when it comes to firearms, emotional thinking predominates on both sides of the debate.

Another reader opines that weapons themselves are a "good investment" which may or may not be true.  If you buy a firearm for retail price at a gun dealer, odds are it will merely hold its value, or likely, depreciate, because like with gold, they are making more every day.   Few barriers to entry and assembly lines cranking them out - and little fear of "Obama taking your guns" means that supply will always outstrip demand, even if there are spot shortages.

You could, if you were smart, buy weapons on the secondhand market and then re-sell them for a profit.   recently, there was a glut of such product on the market, as a lot of folks who spent $1000 or more on a firearm on the premise "Obama will take our guns away" realized a year later that they had a very expensive paperweight in their living room, and that they had important bills to pay and real expenses in life and couldn't really afford such a luxury as an AR-15

As this chart illustrates, gun sales spiked in 2013, then plummeted in 2014.   They will likely go up in 2016 as there is more talk of expanding regulations (and the NRA cranks up the "gun ban" siren).   But I think long term, this has all the makings of a gun bubble.  The market will be saturated eventually, and people will realize that the government can't "take their guns away" after all.   If Obama can't do it in eight years, no one can.

And that is why you see all these "GUN AND PAWN" places in rural areas - guns are probably the most pawned item on the planet.   There is an old redneck joke that goes something like this:  "Oh, yea, buddy?  Well, if you piss me off again, I'll go get my gun out of pawn and shoot you!" - which sort of illustrates how "gun ownership" works in the rural South.

So you could buy low, I guess, between school shootings, and then sell high when the NRA cranks up "gun confiscation" rhetoric.   But then again, I suppose it would be a pretty marginal business, much like buying and selling used cars.

Buying and HOLDING guns as an investment would be far trickier.   Unless they have collector item value (antiques, etc.) they likely won't hold their value much.   The rifle you buy at Wal-Mart is going to sell at Wal-Mart for the same price next year (adjusted for inflation) and no one is going to pay you huge amounts of money for a used weapon over a new one.

I suppose, given the loophole in firearms laws, you could buy from legitimate dealers and then sell to friends who don't want to wait for background checks.   But that might violate a number of laws and land you in jail.  Not recommended.

It is sad that people can't analyze things without investing a lot of emotional freight into them.