Should you invest in pills or joints?

Ageing populations in the developed world and rising prosperity in emerging markets should be a great boon for the healthcare industry in the coming decades. But which parts of the healthcare industry and which companies should investors be looking to for the best returns?

Today, I’m assessing two FTSE 100 contenders: medical devices manufacturer Smith & Nephew (LSE: SN), which has just released its Q3 results, and pharmaceuticals play AstraZeneca (LSE: AZN).

In rude health

Smith & Nephew posted underlying revenue growth of 2% in Q3, with chief executive Olivier Bohuon reporting “a continuation of many of the trends seen in the previous period”. In particular, strong revenue growth continued in sports medicine joint repair (up 8%) and knee implants (up 4%).

Smith & Nephew generates about 85% of its revenue from established markets, and these markets saw 1% growth. Emerging markets revenue was up 6%, with China returning to growth after a period of challenging trading conditions.

I see plenty of scope for Smith & Nephew to expand strongly in emerging markets in the coming years from what is a relatively low base. This should provide a turbo boost to the group’s more modest top-line growth in established markets.

For the current year, City earnings forecasts give the company a P/E of 17.7 at a share price of 1,135p, but analysts expect revenue growth to accelerate to 4.5% in 2017, driving a 12% rise in earnings and bringing the P/E down to a more appealing 15.7.

Smith & Nephew reports its results and declares its dividend in dollars, so the weakening of sterling since the EU referendum is set to deliver a significant boost. Last year, the company declared a dividend of 30.8 cents, which translated into a sterling payout of 20.68p. However, this year, we’re looking at a prospective 4.24% increase in the dollar dividend to 32.1 cents, but a whopping 26.6% rise in the sterling payout to 26.18p, giving a handy yield of 2.3%.

On the road to recovery

Astra Zeneca has greater penetration of emerging markets than Smith & Nephew (25% of revenues versus 15%), but there’s been an overriding negative factor in the pharma group’s performance in recent years; namely, a spate of expiring patents on some of its bestselling drugs. This has hit top-line and bottom-line performance.

AstraZeneca isn’t quite out of the woods yet, but a reinvigorated drugs pipeline is set to start bearing fruit in the next few years. The company’s long run of earnings declines is forecast to bottom out with a 4% fall from 2016 to 2017, giving P/Es of 13.4 and 14 at a share price of 4,450p

As with Smith & Nephew, Astra’s shareholders can look forward to a dividend boost this year due to the weakness of sterling. Astra declared a $2.80 dividend last year and is expected to pay the same this year. However, while last year’s payout translated to 188.5p, this year’s looks like being something like 223p, giving a cracking yield of 5%.

So, AstraZeneca has a cheaper earnings multiple and a higher yield than Smith & Nephew, but the medical devices company has good existing momentum in its business. I believe these factors balance out, and that both stocks are very buyable at current levels, based on the hugely positive trends for healthcare demand in the coming decades.

Another top pick

Dividends make a significant contribution to total shareholder returns and I'm expecting AstraZeneca and Smith & Nephew to deliver in spades on this front over the long term.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended AstraZeneca. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.