Align Technology’s stock price has taken a beating over the past six months, shedding 23% of its value and falling to $128.81 per share. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.

Is there a buying opportunity in Align Technology, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free for active Edge members.

Why Is Align Technology Not Exciting?

Even with the cheaper entry price, we're cautious about Align Technology. Here are three reasons you should be careful with ALGN and a stock we'd rather own.

1. Weak Sales Volumes Indicate Waning Demand

Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Dental Equipment & Technology company because there’s a ceiling to what customers will pay.

Align Technology’s clear aligner shipments came in at 644,370 in the latest quarter, and over the last two years, averaged 2.8% year-on-year growth. This performance slightly lagged the sector and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability.

2. Shrinking Adjusted Operating Margin

Adjusted operating margin is a key measure of profitability. Think of it as net income (the bottom line) excluding the impact of non-recurring expenses, taxes, and interest on debt - metrics less connected to business fundamentals.

Analyzing the trend in its profitability, Align Technology’s adjusted operating margin decreased by 7.5 percentage points over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its adjusted operating margin for the trailing 12 months was 21.4%.

3. New Investments Fail to Bear Fruit as ROIC Declines

ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Align Technology’s ROIC has unfortunately decreased significantly. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

Final Judgment

Align Technology isn’t a terrible business, but it doesn’t pass our quality test. After the recent drawdown, the stock trades at 12.2× forward P/E (or $128.81 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're fairly confident there are better stocks to buy right now. We’d recommend looking at one of our all-time favorite software stocks.

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