The FTSE 100’s Smith & Nephew (LSE: SN) has fallen 8% from its 1 August 12-month high of £12.46. That day saw the release of better-than-expected H1 2024 results.
However, the day after that the market began to slide following worse-than-expected US jobs data, taking Smith & Nephew’s share price with it.
This has created a rare opportunity to buy the stock on a dip, I think.
How undervalued are the shares now?
Even before the FTSE 100 sell-off, the medical technology stock looked a bargain to me.
On the key price-to-book ratio (P/B) stock valuation measure, it now trades at 2.5 against a peer group average of 3.6.
On the price-to-sales ratio (P/S), it is currently at 2.3 compared to the 3.3 average of its competitors.
To work out how much value is in the stock, I ran a discounted cash flow analysis using other analysts’ figures and my own.
This shows the shares to be around 35% undervalued at their present price of £11.46. So a fair value for the stock would be £17.63.
It may go lower or higher than that, but it underlines to me how cheap the stock looks.
How strong is the business?
Its H1 results showed trading profit jumping 12.8% from H1 2023 — to $471m, ahead of analysts’ forecasts of $462m. There was also a rise in trading profit margin to 16.7% from 15.3%. And adjusted earnings per share (EPS) increased 7.7% to 37.6 cents (29.5p).
These numbers in part reflected major advances in some of the firm’s key products in that period.
For example, it fully commercially launched the AETOS shoulder system – one of the fastest-growing markets in orthopaedics. It also gained US regulatory approval for its new CATALYSTEM hip technology.
A risk for the firm is a fundamental failure in any of its core products, which could prove costly to fix. Additionally, any litigation arising from the ill effects of any of its products could damage its reputation.
However, consensus analysts’ forecasts are that its earnings will grow 22.8% a year to end-2026. EPS is expected to rise by 27.1% a year to that point.
So will I buy the shares?
A key consideration in stock selection is knowing where one is in the investment cycle, in my experience.
The further a person is from when they want to retire, the longer the markets have to recover from any shocks. The same is true for individual stocks as well.
This means two things to me in practical terms. First, the younger a person is, the more risk they can afford to take in the stocks they choose. And second, they can focus more on a balance of growth shares and those geared to paying regular dividend income.
I am well over 50 now and am focused almost entirely on these high-yielding stocks. I am using the dividends paid me to increasingly reduce my working commitments and will continue to do so.
Smith & Nephew currently yields 2.6%. This is better than nothing but nowhere near the 9% average of my high-yielding shares.
Consequently, I will not be buying the stock. If I were 10 years younger I would do so because of its significant undervaluation and the firm’s strong growth prospects.
