Head To Head: Shire vs Smith & Nephew

Published in Investing on 22 November 2012

Which blue-chip health company should you buy today?

In this series, some of your favourite FTSE 100 (UKX) shares go head to head in a three-round contest for superiority.

In Round 1, the firms fight on earnings; in Round 2, on dividends; and Round 3 is a battle of the balance sheets. The winner will be the company that has racked up most points at the end of the contest.

Stepping into the ring today are drugs company Shire (LSE: SHP) and medical devices firm Smith & Nephew (LSE: SN).

Smith & Nephew has matched strides with the FTSE 100 over the past year, both having risen a bit over 10%. Shire has moved in the opposite direction by a similar degree: down 12%.

Let's take our seats at ringside.

Round 1: earnings

 ShireSmith & Nephew
Recent share price1,770p645p
Last year price-to-earnings (P/E) ratio17.413.7
Current year forecast P/E14.013.6
Three-year earnings per share (eps) compound annual growth rate (CAGR) (%)3710
Current year forecast eps growth (%)251
Forecast operating margin (%)2923

Source: Digital Look, Morningstar, company reports. Winners in bold.

Smith & Nephew scores points for its relatively low P/E, but Shire edges the first round thanks to very strong earnings growth and a superior operating margin.

Round 2: dividends

 ShireSmith & Nephew
Last year dividend yield (%)0.51.7
Current year forecast dividend yield (%)0.62.3
Three-year dividend CAGR (%)1510
Current year forecast dividend growth (%)1435
Forecast dividend cover11.83.2

Source: Digital Look, Morningstar, company reports. Winners in bold.

In a reversal of round one, Smith & Nephew edges the second round, scoring on yield -- not exactly hard to better Shire's -- and taking a big-hitting point for forecast dividend growth.

You may be wondering why Smith & Nephew's forecast dividend growth is so far above the historical CAGR, especially when eps growth is forecast to be minimal this year. The reason is that in the company's latest interim results the Board announced a step-change increase in the level of dividend payout and a move to a progressive dividend policy. The interim dividend was lifted 50%. After this year's bumper rise, dividends will be broadly based on the group's "underlying growth in earnings, while taking into account capital requirements and cash flows".

Round 3: balance sheet

 ShireSmith & Nephew
Price-to-book (P/B) ratio4.92.9
Net gearing (%)154

Source: Digital Look, Morningstar, company reports. Winners in bold.

Smith & Nephew finishes with a flourish, taking both points in the final round, giving it victory in two rounds to one. The overall points tally is Smith & Nephew seven and Shire five.

Post-match assessment

Shire and Smith & Nephew are on higher P/Es and lower yields than the Footsie's pharma giants, GlaxoSmithKline (LSE: GSK) and AstraZeneca (LSE: AZN).

Part of the reason for Shire and Smith & Nephews 'growthier' ratings is that, though the companyies aren't exactly small, it's easier for investors to envisage them doubling their market capitalisation than it is to imagine super-heavyweights GlaxoSmithKline and AstraZeneca doubling theirs.

Smith & Nephew took all five points on the 'value' measures I use in these head-to-head contests. In addition, the company's earnings -- and dividend-growth records, and dividend cover -- are very decent; and it has sound business fundamentals in terms of a good operating margin and minimal gearing.

Supporters of Shire can point to its even stronger earnings growth record, even higher operating margin and dividend cover, and a perfectly respectable level of gearing, well below that of the average FTSE 100 company. Furthermore, Shire's forecast P/E isn't that much higher than Smith & Nephew's, while its forecast eps growth certainly is.

For investors more interested in capital-growth potential than large, immediate cash-in-hand dividends, both companies in today's contest appear to be not unreasonably priced. Shire is an out-and-out blue-chip growth stock, while Smith & Nephew leans a little more towards growth and income with its new dividend policy.

Growth and income can be a powerful combination, as top equity-income fund manager Neil Woodford has shown. Woodford's funds have outperformed the market by more than 300% over the past 15 years.

If you'd like to learn about this City maestro's enormously successful investing strategy and the dividend-paying blue chips he currently favours, help yourself to the exclusive Motley Fool report, 8 Shares Held By Britain's Super Investor”. The report is available for a limited time only, but you can download it for free right now: simply click here.

> G A Chester does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares in Smith & Nephew.

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