Down 27%, but set for major growth, this hidden FTSE gem looks cheap to me

This powerhouse FTSE stock has embarked on a new growth strategy that’s already showing good results, but it looks undervalued to me.

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Several stocks in the various FTSE indexes benefit from exceptional name recognition among retail investors. Or from operating in one of the sectors considered sexy or glamorous – fashion, for instance, finance, or something high-tech.

None of these labels could be applied to Smith & Nephew (LSE: SN), I think it’s fair to say. It makes medical equipment, including knee joints, advanced wound management products, and various other things most of us would rather not think about.

Sexy and glamorous they are not, which is partly why the stock’s down 27% from its 2 May 12-month high, I think.

But the products are essential, and the company’s a global powerhouse in its field. This difference between perception and reality makes its share price look a bargain to me.

Undervalued giant?

On the key price-to-earnings (P/E) stock valuation measurement, it trades at 39.6. This looks cheap compared to its competitors, which have an average P/E of 47.2.

So, how much of a bargain are the shares exactly? A discounted cash flow model shows Smith & Nephew stock to be around 36% undervalued at the present price of £9.59. So a fair value would be about £14.98.

This doesn’t necessarily mean it will ever reach that price. But it confirms to me that it looks like a major bargain right now.

Strong growth ahead?

In July 2022, the company announced its 12-Point Plan broadly aimed at boosting growth, profitability and shareholder returns.

One key target is to regain momentum in its Orthopaedics business through differentiated technology. Its 2023 results showed 5.7% underlying growth here compared to 1.9% in 2022.

Another is to accelerate growth in its already-strongly-performing Advanced Wound Management, Sports Medicine and Ear, Nose and Throat business units. In 2023, it more than tripled the pace of cross-business unit deals between the Orthopaedics and Sports Medicine businesses.

And a further target is to improve productivity to increase its trading profit margin. Its 2023 results showed improved productivity added 1.6% to its trading profit margin over 2022.

One risk in the stock is that its 12-Point Plan suffers delays for some reason. Another is if inflation and interest rates start to rise again in the US, causing an economic slowdown, as this is its biggest market.

However, consensus analysts’ estimates are now for earnings to grow 21% a year to the end of 2026. Earnings per share are forecast to increase to 23% a year as well to that point.

Will I buy it?

When I turned 50 a while back, I decided to focus on stocks that pay high dividends. The idea is that these generate sufficient income for me to continue to reduce my working commitments.

Smith & Nephew’s 2023 dividend was 38 cents – around 31p – a share. So, based on the current share price of £9.59, this gives a yield of 3.2%.

This isn’t far off the average FTSE 100 yield of 3.8%, but it’s below my minimum requirement of 7%.

However, if I was 20 again and starting on my investment journey, it’s exactly the sort of stock I’d buy.

It appears to have great growth potential and looks very undervalued. I also think that based on these growth prospects, there’s every chance its dividend can rise over time.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Simon Watkins has no position in any of the shares mentioned. The Motley Fool UK has recommended Smith & Nephew Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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