Should I Invest in Smiths Group?

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I'm looking at Smiths Group  (LSE: SMIN  ) , the diversified engineering company.

With the shares at 1240 pence, Smiths' market cap. is £4,870 million.

This table summarizes the firm's recent financial record:

Year to July

2008

2009

2010

2011

2012

Revenue (£m)

2,321

2,665

2,770

2,842

3,030

Net cash from operations (£m)

198

332

411

322

332

Adjusted earnings per share

74.5p

72.4p

84.6p

86.5p

92.6p

Dividend per share

34p

34p

34p

36.25p

38p

There is a cautionary flavor to Smiths' recent outlook statement, which seems to anticipate generally flat trading across the firm's five divisions in the short term. The company provides engineering products, components, and services in areas such as threat and contraband detection, medical devices, energy, communications and aerospace.

North America is important, delivering around 50% of the firm's revenues. That's why U.S. government budget cuts in defense and other areas, and an incoming medical device tax, are weighing on the company's forward revenue growth and profit forecasts.

That said the directors seem to have confidence in medium- to long-term growth prospects. If Smiths can overcome the short-term headwinds it could go on to deliver a satisfactory total-return performance for investors in the end.

Smith Group's total return potential

Let's examine five indicators to help judge the quality of the company's total-return potential:

  1. Dividend cover: adjusted earnings covered last year's dividend around 2.4 times. 4/5
  2. Borrowings: net gearing around 70%. Net debt about 2.1 times operating profit. 3/5
  3. Growth: flat cash flow struggles to support growing revenue and earnings. 3/5
  4. Price to earnings: a forward 12.4 overstates growth and yield expectations. 2/5
  5. Outlook: satisfactory recent trading and a cautious outlook. 2/5

Overall, I score Smiths 14 out of 25 and I don't think the firm is likely to out-pace the wider market's total return for a while.

Foolish summary
The dividend seems well covered by earnings, but cash flow has been flat and debt is creeping up. The outlook is cautious but the valuation seems less so! I'm keeping Smiths on watch for now, despite the 3.4% forecast dividend yield.

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