Is Align Technology, Inc.'s (NASDAQ:ALGN) P/E Ratio Really That Good?
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Align Technology, Inc.'s (NASDAQ:ALGN) P/E ratio and reflect on what it tells us about the company's share price. Align Technology has a P/E ratio of 33.69, based on the last twelve months. In other words, at today's prices, investors are paying $33.69 for every $1 in prior year profit.
View our latest analysis for Align Technology
How Do I Calculate Align Technology's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Align Technology:
P/E of 33.69 = $175.84 ÷ $5.22 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Align Technology's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see Align Technology has a lower P/E than the average (40.5) in the medical equipment industry classification.
Align Technology's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Align Technology, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's nice to see that Align Technology grew EPS by a stonking 42% in the last year. And it has bolstered its earnings per share by 24% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Align Technology's P/E?
Align Technology has net cash of US$721m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Align Technology's P/E Ratio
Align Technology has a P/E of 33.7. That's higher than the average in its market, which is 17.8. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Align Technology may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
