Value stocks are those that trade at a discount to their intrinsic or book value. In other words, they may appear cheap.
However, it can take years or even decades for unvalued stocks to realise their potential. That’s what Warren Buffett, one of the most famous value investors, tells us.
Smith & Nephew
Today, I’m taking a closer look a FTSE 100 medical device giant Smith & Nephew (LSE:SN). The pandemic hugely impacted business with global resources being directed towards treating Covid rather than hip replacements — Smith & Nephew’s bread and butter.
A global leader in the medical technology industry, with a strong presence in over 100 countries worldwide, Smith & Nephew has core markets in advanced wound treatment, sports medicine, ENT, as well as orthopaedics.
Smith & Nephew shares are down 20% over six months, compounding losses during the pandemic. Part of this can be traced to slightly-lower-than-expected first-half profits. The company blamed higher marketing costs and input inflation for the weaker results.
Moreover, investors raised concerns that new weight-loss drugs, such as Novo Nordisk‘s Wegovy, could reduce demand for hip replacements in the long run.
As Smith & Nephew is a major player in the hip replacement market, this could have a significant impact on future sales.
As is evident is the below chart, the company is trading at near half its highs.
A value play
Smith & Nephew remains confident that demand for hip replacements will endure despite the impact of new weight loss drugs.
And while we wouldn’t expect to see an immediate impact, analysts anticipate explosive earnings growth in the coming years.
The below table shows forecast EPS growth and the forward price-to-earnings ratio for each year.
It’s also worth recognising the pace of growth here. It may be slightly misleading because of the impact the pandemic and supply chain constraints had on profitability over the past three years. But the forward growth projects lead to a PEG ratio of 1.2.
The price/earnings-to-growth (PEG) ratio is a valuation metric that compares a stock’s price-to-earnings ratio (P/E ratio) to its expected earnings growth rate. A ratio below one is normally a good sign a company is undervalued. But it’s hard to come across too many measuring under one these days.
The above valuation metrics are fairly attractive. The company might not appear cheap today, but earnings projects bring the valuation down over the medium term. And the PEG ratio suggests earnings will continue to improve.
This positivity is reflected in the company’s average price target of £12.88 and the number of ‘buy’ versus ‘sell’ ratings. That target is 25% above the current share price.
Among analysts, Smith & Nephew has eight ‘buy’ ratings, four at ‘outperform’, four at ‘hold’ and just one at ‘underperform’. It’s always nice to see your own estimations supported by major institutions in the world of equities and finance.
I own the stock in my SIPP, but I’m considering adding more. It’s certainly among the most appealing value opportunities on the index, and it’s hard to come across stocks with low PEG values.