When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Align Technology, Inc. (NASDAQ:ALGN) as a stock to avoid entirely with its 53.8x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Recent times haven't been advantageous for Align Technology as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.
View our latest analysis for Align Technology
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.
Retrospectively, the last year delivered a frustrating 27% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 79% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 27% each year during the coming three years according to the analysts following the company. With the market only predicted to deliver 12% per annum, 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 Final Word
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
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. It's hard to see the share price falling strongly in the near future under these circumstances.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Align Technology with six simple checks on some of these key factors.
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.