With an average analyst rating of buy, Smith & Nephew is clearly an analyst favorite. But the analysts could be wrong. Is SNN overvalued at today's price of $31.02? Let's take a closer look at the fundamentals to find out.
The most common valuation metric for stocks is the trailing price to earnings (P/E) ratio. Smith & Nephew has a P/E ratio of 60.8 based on its 12 month trailing earnings per share of $0.51. Considering its future earnings estimates of $1.89 per share, the stock's forward P/E ratio is 16.4. In comparison, the average P/E ratio of the Health Care sector is 24.45 and the average P/E ratio of the S&P 500 is 15.97.
We can also compare the ratio of Smith & Nephew's market price to its book value, which gives us the price to book, or P/B ratio. A company's book value refers to its present equity value -- or what is left over when we subtract its liabilities from its assets. SNN has a P/B ratio of 2.6, with any figure close to or below one indicating a potentially undervalued company.
A comparison of the share price versus company earnings and book value should be balanced by an analysis of the company's ability to pay its liabilities. One popular metric is the Quick Ratio, or Acid Test, which is the company's current assets minus its inventory and prepaid expenses divided by its current liabilities. Smith & Nephew's quick ratio is 0.891. Generally speaking, a quick ratio above 1 signifies that the company is able to meet its liabilities.
The final element of our analysis will touch on Smith & Nephew's ability to generate cash for the benefit of its shareholders or for reinvesting in the business. For this, we look at the company's levered free cash flow, which is the sum of all incoming and outgoing cash flows, including the servicing of current debt and liabilities. Smith & Nephew has a free cash flow of $110,000,000.00, which it uses to pay its shareholders a 1.2% dividend.
At Market Inference, we will keep monitoring Smith & Nephew to see if the analysts were right to recommend the stock despite its valuation issues. We recognize that numbers don't always tell the whole story, and that qualitative factors often set high performing investments apart from the rest.
