One of the first rules about owning stocks is not to get emotional — period.  

However, when a large number of humans get together to trade stocks, that rule is almost always immediately thrown out of the window. Stocks are traded based on momentum rather than the true, underlying fundamentals of the business.

This affects stocks in many different sectors: fervor over the latest technology, energy or commodity companies based on supply and demand, or biotech stocks that rise and fall according to a medical breakthrough. 

Gun manufacturers are especially emotion-driven. Rarely have I ever heard a pundit or analyst tout a gun stock based on fundamentals — at least not with genuine conviction. 

Over the past decade stocks of gun makers have rocketed up, mainly due to fear of stricter government regulation. But what if you owned a gun manufacturer stock because it was just a great business?

Sturm, Ruger and Co., Inc. (NYSE: RGR), popularly known as Ruger, is a classic example of an extremely healthy baby that’s been thrown out with the bathwater. 

With a market cap of just over $900 million, Ruger has made a solid name for itself making high quality products that create fiercely loyal customers. Many American kids have learned how to shoot using Ruger’s famous 10/22 .22-caliber rifle.
 
But the quality of the company’s stock is as impressive as their products.

Since President Obama’s first election, the stock has increased 1500%. Again, fear is a main driver.

However, fundamentals are now in the driver’s seat. In comparing Ruger’s numbers side by side to those of rival Smith & Wesson Holding Corp. (Nasdaq: SWHC), there is very little competition.

While emotion drove the stock price, Ruger turned it into bottom line results taking annual sales in 2009 from $271 million to a staggering $688 million in 2013. Earnings per share (EPS) followed a similar upward slope zooming from $1.42 to $5.58 over the same time period. 

What’s more impressive is that Ruger has managed to grow with absolutely zero long-term debt on its books. Like any smart company, Ruger depends on the cash it generates to manage — and it’s a lot of cash. Annual cash flow has grown at an average annual rate of 50% over the last three years to $131 million from $52.2 million.

With the right combination of great products, management, and a strong balance sheet, what does the future hold for the company? 

Regulatory risk aside, Ruger looks like a classic private equity target: a healthy, growing small cap company with no debt, strong cash flow and a solid brand name. The stock’s valuation also makes it extremely attractive. Shares are currently off 41% from their 52 week high, forcing the forward PE down to bargain basement territory at just below twelve times projected 2015 earnings.

Risks to consider: The biggest risk facing Ruger, of course, are stricter national gun control laws. However, while the political grandstanding from both sides shifts into overdrive after a tragic shooting that garners national attention, Washington lacks the political chutzpah to actually do anything. A gridlocked congress and a lame duck president are the best situation the National Rifle Association could have. Also, with the lack of any kind of regulatory fear, the run on guns could be over. However, Ruger’s history of brand loyalty from its customers should help support any decline.

Action to take –> While the momentum factor affecting Ruger’s stock may be gone, the company’s solid fundamentals and discounted price make for an exceptional contrarian opportunity. 

Shares currently trade at around $50.70, a substantial discount to their all-time high. The stock’s forward PE is a compelling 11.9 with an attractive dividend yield of 3.6%. Based on the company’s solid operating history, the stock is a timely opportunity. If the company can continue to execute at its current rate, shares have the potential to reach $67 in 12 to 18 months. When combine with the dividend that represents a potential total return of nearly 36%.

Ruger sports a solid 3.6% dividend yield and fundamentals that promote long-term growth. These factors make it a great candidate for our premium newsletter, High-Yield Investing, which just released a new report about a little-known group of investments with some of the market’s highest yielders — up to 12%. To learn more about this opportunity, click here.