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Here's Where Things Went Wrong for American Outdoors Brand Corp in 2017

Some industries like private prisons and for-profit education got a big boost from the 2016 election, but the gun industry didn't.

The firearms industry generally benefits from a pro-Second Amendment president, but coupled with a supportive House and Senate that would inhibit more restrictive gun laws from being enacted, there's less of a rush for people to buy guns and ammunition right this minute. 

That swing in policy expectations meant a big shift in the short-term outlook for American Outdoor Brands (NASDAQ: AOBC) and Sturm, Ruger (NYSE: RGR) this year. But what many didn't see coming was the rebound in their stocks.

Image source: Getty Images.

A skewed picture of things

Politics aside, gun sales continue to grow. It might not be at the same torrid pace they had been on throughout 2016 when a different electoral outcome was anticipated, but they remain elevated over 2015, the prior record year.

Every month the FBI releases data on the number of criminal background checks it conducts on individuals wanting to purchase firearms, and through October the numbers are running some 15% ahead of 2015. While that might explain why shares of American Outdoor Brands and Ruger recovered almost all of their losses by June, it doesn't satisfactorily explain what's happened since.

After hitting new 52-week highs, both gunmakers have lost considerable value: Ruger is down 28% while the owner of Smith & Wesson has lost nearly 50%.

AOBC data by YCharts.

To be sure, both manufacturers have reported substantially lower gun sales. American Outdoor Brands reported sales were down almost 8% in its fiscal fourth quarter that ended April 30 and were down 49% in its fiscal first quarter that ended July 31.  Similarly, Sturm Ruger, whose earnings periods follow the calendar year, reported sales were down 21% and 35%, respectively, for its second and third quarters.

Both gunmakers results deteriorated rapidly following the summer months, something the FBI data would seeming show to be a bit incongruous, but we need to look at the adjusted numbers to get to the root of the cause.

Getting a more granular look

Following the FBI's data release, the industry trade group National Shooting Sports Foundation goes through the numbers and removes background checks for people who already have concealed carry permits. In addition to investigating the backgrounds of new gun buyers, certain states also go over existing concealed carry permit holders to see if anyone has been arrested or has become unable to lawfully carry a firearm since they last checked. The NSSF's adjusted numbers give a truer picture of gun industry demand as it only looks at new gun buyers, and what its data shows is that beginning in July, current year background checks fell behind not only 2016's numbers, but also 2015.

Data source: National Shooting Sports Foundation. Chart by author.

Where the figures from the first half of the year had been running 8% higher over the same period in 2015, in July they lagged by nearly 4% and through October, the five-month period is coming up 16% short. Although year-to-date the current numbers are still barely running ahead of 2015, the trend suggests they could end the year below those numbers.

A different dynamic at work

In the past, tragic mass shootings like the ones that have occurred over the past few months would push gun sales as owners and enthusiasts rushed to make a purchase before strict new regulations could be enacted. That hasn't been happening recently though. 

Industry growth still remained on an upward trajectory. Since Donald Trump's election, however, there no longer seems to be the urgency to buy firearms.

That's not to say gun sales are really declining all that much. Current year numbers still show sales hewing fairly close to the long term trendline, and that suggests that although shares of American Outdoor Brands have been kneecapped, it actually represents a very good value.

The Smith & Wesson owner trades at just eight times earnings and next year's estimates as well as only a fraction of its sales and long-term earnings growth forecast. And at 14 times the free cash flow it produces, it's a fairly discounted stock. 

But for investors looking for where things went wrong for American Outdoor Brands, the proximate cause can be laid at Trump's election. Because of the expectation of more gun-friendly policy measures, people simply aren't stocking up on guns an ammunition as much as they had during the past administration. 

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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.