Smiths Group (LSE: SMIN) is far too cheap, I believe. The company, which manufactures a variety of high-quality products for the medical industry, has grown steadily over the past few decades creating billions of pounds in shareholder value along the way.
Indeed, the business has been able to achieve an average operating profit margin of 15% over the past six years, as well as an average return on equity of around 20%. With returns high, Smiths has been able to compound book value per share at a rate of 16% per annum for the past six years.
It looks as if this is set to continue. Today the firm announced in a trading update that while revenue during the first quarter decreased 2% on an underlying basis, primarily due to order timing, management expectations for the full year are unchanged and the group is expected to return to growth in 2018.
To help its growth, one of the group’s subsidiaries acquired the heating element division of Osram, broadening its portfolio into faster-growing engineered heating solutions.
For the full-year, City analysts are expecting the company to grow earnings per share by around 7.5%. Growth of 6.5% is projected for the year after.
As well as the steady expansion, I believe Smiths’ shares are undervalued. At the time of writing the shares trade at an EV/EBITDA ratio of 8.7 compared to the sector average of 14.1, a discount of nearly 40%. On top of this depressed valuation, shares in Smiths support a dividend yield of 3%. The payout is covered 2.3 times by earnings per share leaving plenty of room for dividend growth and further investment in the business.
Vedanta (LSE: VED) is another FTSE 100 income stock that looks to me to be undervalued. Over the past few years, investors have given the mining sector a wide berth due to concerns about debt and fluctuating commodity prices. But during the past 12 months, it has become clear that the industry is getting itself in order with debt falling, profits rising and commodity prices stabilising.
Vedanta is no different. At the end of last week, the company revealed a 37.4% rise in half-year profit. Operating profit from its zinc business surged nearly 80%, as zinc production in India jumped 42.1%. This means that after three years of turbulence, the firm is now firmly back in the black.
Undervalued dividend play
For the full year ending 31 March 2018, City analysts are projecting a pre-tax profit of £1.8bn, up from last year’s £1bn, and earnings per share of 65.2p, up from last year’s 0.7p. Further growth is projected for the following fiscal year. Earnings per share are expected to expand 51% year-on-year to 99p comfortably covering the firm’s dividend distribution of 42p.
These projections indicate that shares in Vedanta are currently trading at a forward P/E of 10.8 and yield 4.8%. Considering the firm’s rapid earnings expansion, and room for further dividend growth, this valuation looks to me to be too good to pass up.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.