Align Technology's (NASDAQ:ALGN) Strong Earnings Are Of Good Quality

Align Technology, Inc. (NASDAQ:ALGN) recently posted some strong earnings, and the market responded positively. Our analysis found some more factors that we think are good for shareholders.

Check out our latest analysis for Align Technology

Examining Cashflow Against Align Technology's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2023, Align Technology recorded an accrual ratio of -0.13. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of US$786m in the last year, which was a lot more than its statutory profit of US$445.1m. Align Technology's free cash flow improved over the last year, which is generally good to see.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Align Technology's Profit Performance

As we discussed above, Align Technology has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Align Technology's statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 26% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Ultimately, this article has formed an opinion based on historical data. However, it can also be great to think about what analysts are forecasting for the future. At Simply Wall St, we have analyst estimates which you can view by clicking here.

This note has only looked at a single factor that sheds light on the nature of Align Technology's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.