Align Technology, Inc. (NASDAQ:ALGN) Not Flying Under The Radar

Align Technology, Inc.'s (NASDAQ:ALGN) price-to-earnings (or "P/E") ratio of 39.7x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Align Technology certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Align Technology's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 24%. Still, incredibly EPS has fallen 37% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 21% per annum as estimated by the analysts watching the company. With the market only predicted to deliver 11% each year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Align Technology's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Align Technology's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Align Technology with six simple checks.

If these risks are making you reconsider your opinion on Align Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.