Align Technology (NASDAQ:ALGN) has had a rough three months with its share price down 21%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Align Technology's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Align Technology is:

12% = US$447m ÷ US$3.8b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.12.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Align Technology's Earnings Growth And 12% ROE

To start with, Align Technology's ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. As you might expect, the 22% net income decline reported by Align Technology is a bit of a surprise. So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

That being said, we compared Align Technology's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 11% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ALGN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Align Technology Using Its Retained Earnings Effectively?

Align Technology doesn't pay any regular dividends, meaning that potentially all of its profits are being reinvested in the business, which doesn't explain why the company's earnings have shrunk if it is retaining all of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Conclusion

Overall, we feel that Align Technology certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.