Should I Invest in Smith & Nephew?

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 year 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 Smith & Nephew  (LSE: SN  ) (NYSE: SNN  ) , the medical devices company.

With the shares at 729 pence, Smith & Nephew's market cap. is £6,583 million.

This table summarizes the firm's recent financial record:

Year to December 2008 2009 2010 2011 2012
Revenue (in millions of dollars) 3,801 3,772 3,962 4,270 4,137
Net cash from operations (in millions of dollars) 566 719 859 842 902
Adjusted earnings per share (cents) 55.6 65.6 73.6 74.5 75.7
Dividend per share (cents) 13.08 14.39 15.82 17.4 26.1

In its recent first-quarter update, Smith & Nephew revealed a 1% decrease in overall revenue compared to the previous year's comparator. Within that result, emerging markets turnover grew 19%, with most of the trading weakness coming from Europe. Last year the firm derived 12% of its business from emerging markets, 40% from the U.S. and the rest from Canada, Europe, Japan, Australia and New Zealand. So, although growth in emerging markets is encouraging, it currently constitutes a small portion of the company's trade.

Demand for Smith & Nephew's goods and services seems unlikely to wane given the seemingly diametric drivers of longevity and war. The firm's products -- which include joint replacements for knees hips and shoulders; tools for minimally invasive surgery; advanced wound dressings; and assorted nuts, bolts, plates and nails used in trauma surgery -- seem unlikely to spend much time up on the stock shelf.

The solid characteristics of the business led the directors to rebase the dividend up by 50% last year as well as committing to a progressive forward-dividend policy and a share buy-back programme. Such moves make me optimistic about the firm's total-return propects from here.

Smith & Nephew'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 2.9 times. 4/5
  2. Borrowings: net debt is running at about 35% the level of operating profit. 4/5
  3. Growth: growing cash flow provides firm support for rising earnings and flat revenue. 4/5
  4. Price to earnings: a forward 13 slightly overstates growth and yield expectations. 2/5
  5. Outlook: satisfactory recent trading and an optimistic outlook. 3/5

Overall, I score Smith & Nephew 17 out of 25, which encourages me to believe the firm has some potential to out-pace the wider market's total return, going forward.

Foolish summary
Solid, cash-backed dividend cover, low debt, and a record of steady growth are all attractive features. The valuation seems full given the outlook for earnings growth and dividend yield. Considering those factors, I'm putting Smith and Nephew on my watchlist for the time being.

But I'm excited about an idea from the Motley Fool's top value investor who has discovered what he believes is the best income generating share-play for 2013. He set's out his three-point investing thesis in a report called "The Motley Fool's Top Income Share For 2013," which I recommend you download now. For a limited time, the report is free so, to download it immediately, and discover the identity of this dividend-generating star, click here.


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