Returns On Capital Signal Tricky Times Ahead For Align Technology (NASDAQ:ALGN)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Align Technology (NASDAQ:ALGN), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Align Technology:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.16 = US$657m ÷ (US$5.9b - US$1.9b) (Based on the trailing twelve months to December 2022).

Thus, Align Technology has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Medical Equipment industry average of 10.0% it's much better.

See our latest analysis for Align Technology

In the above chart we have measured Align Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Align Technology here for free.

So How Is Align Technology's ROCE Trending?

In terms of Align Technology's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 28%, but since then they've fallen to 16%. However it looks like Align Technology might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Align Technology's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 22% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

Like most companies, Align Technology does come with some risks, and we've found 1 warning sign that you should be aware of.

While Align Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.