When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Align Technology, Inc. (NASDAQ:ALGN) as a stock to avoid entirely with its 36.7x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Align Technology certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Align Technology's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings growth, the company posted a terrific increase of 45%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 32% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 22% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 10% per year, which is noticeably less attractive.
With this information, we can see why Align Technology is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
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. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. 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. Take a look at our free balance sheet analysis for Align Technology with six simple checks on some of these key factors.
Of course, you might also be able to find a better stock than Align Technology. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.
