Desktop Metal Jumps 55%
Back in April, InvestorPlace CEO Brian Hunt and I were talking about long-term investing.
“They still more room to fall,” I shook my head. “If Jerome Powell is driving inflation out, he hasn’t even left the driveway yet.”
But just two weeks later, I would change my mind about one pick:
Desktop Metal (NYSE:DM).
After falling another 65% to $1.50 on worse-than-expected quarterly figures, the high-quality growth stock had finally become too cheap to ignore.
I messaged him immediately. DM had hit my buyout target price.
Since then, shares have rebounded by 55%.
And today, I have one more pick to add to that high-quality list. And it’s a company most have never heard of…
Align Technology (NASDAQ:ALGN).Source: Evellean / Shutterstock.com
The High-Quality Stock You Need to Buy Right Now
Yesterday, I introduced five stocks that scored top marks on the Profit & Protection “quality” score.
But they all had one thing in common:
The ability to generate high returns over long periods of time.
It’s the same driver that’s helped Home Depot (NYSE:HD) turn $10,000 investments into millions of dollars. And it’s the driving force behind my Perpetual Money Machine strategy for long-term investing.
But one of these companies also has “growth” and “value” scores that put firms like Desktop Metal in the core Profit & Protection portfolio. And that makes it the one high-quality stock you need to buy right now.
Align Technology: The Highest Quality Firm No One’s Heard Of
Quality: A+ | Growth: A- | Value: B | Overall A
On Thursday, I introduced Align Technology among my top 5 quality picks.
The maker of Invisalign orthodontics a money-spinning operation. The company has averaged a 61% return on invested capital (ROIC) for the past decade, placing it ahead of 99% of companies in the broad-based Russell 3000. A combination of first-mover advantage and a “razor-razorblade” style business model means the firm has locked orthodontists into its lucrative iTero intraoral scanners.
The high internal returns have worked wonders for the stock. Between 2013 and its 2021 peak, ALGN shares gained 2,450% from internal growth and a $1.4 billion share buyback program.
In every sense, Align Technology is a Perpetual Money Machine that creates significant amounts of re-investable capital.
ALGN beats my other four quant-selected quality picks because it also scores well on “growth” and “value.”
Metal braces still account for 80% of all orthodontics, and Morningstar analysts say that number could be as high as 95% among teenagers.
That’s a massive growth opportunity. Align Technologies has already started advertising and patient education campaigns toward the teen market; don’t be surprised if you see more teenagers forgoing metal braces.
Align also has room for international expansion and utilization. In 2021, the average American doctor produced over 24 cases for Invisalign. Internationally, that figure drops to just 17.5.
Finally, the growing wealth of international consumers will drive demand for better orthodontics. The Chinese market already makes up 7% of sales, a figure that will rise over time.
Analysts now expect Align Technology to grow sales and earnings in the range of 20% to 25%, placing the firm in the top quartile of companies in the Russell 3000 and earning the firm a solid “A-” growth grade.
At the same time, valuation is surprisingly average for a high-ROIC company. Its price-to-sales and other ratios put it in the top 25% of companies in the Russell 3000, keeping it out of the dreaded “quintiles 2 and 3” that underperform.
Align’s $275 price tag is also reasonable from a bottom-up standpoint. A 2-stage DCF model suggests a fair value of $400 if the firm can maintain 25% EBITDA margins over the next five years. Extending that period to ten years puts its value closer to $640 per share.
You can immediately see the importance of maintaining high ROIC over long periods.
Wall Street reviews are a little more mixed. Price targets range anywhere from $260 to $585 from ALGN’s weak Q1 results.
The firm’s dip in cases, however, was more likely about macroeconomic concerns than a shift in the competitive environment. Smile Direct Club (NASDAQ:SDC) posted even worse figures, with a -15.3% sequential decline in cases versus Align’s -5.1%. ALGN’s fair value remains at $550, a 2x upside.
Align Technology, however, does have its share of issues.
On the business side, the company’s high ROIC comes with external costs. ALGN’s rebate structure on the iTero scanner gives dentists the incentive to sell the higher-cost Invisalign, which can run 2x to 4x dearer than rivals. Dental patients are the ones ultimately footing the bill when competitors like Smile Direct Club and AlignerCo fail to gain marketing scale.
Then there’s longevity. Several of Align’s key patents expired in 2017, creating uncertainty around the firm’s ability to generate future returns. Analysts at Morningstar believe that average selling prices could decline 1% annually over the foreseeable future. An investment in ALGN should target a 12 to 24-month holding period.
Finally, a deep recession could impact ALGN’s share price. Invisible orthodontics are generally out-of-pocket expenses — cash-strapped patients can opt to delay or entirely forego tooth-straightening if the economy takes a tumble.
Nevertheless, Align’s cheap valuation, strong growth prospects and unmatched ability to generate returns put it as Profit & Protection’s top “quality” stock to buy today.
The No. 2 Pick
Critical readers might wonder:
Why didn’t ASML (NASDAQ:ASML) make the cut?
After all, the chip-machinery manufacturer is 1) a monopolistic company that 2) is on the cutting edge of an IoT mega-trend and 3) has shares that have fallen -27% this year.
There’s not enough near-term upside.
The company already sports a $235 billion market capitalization. If it were in the S&P 500, the company would be the 25th-largest firm, ahead of pharma giant Merck (NYSE:MRK) and beverage maker PepsiCo (NASDAQ:PEP).
That gives it limited room for growth. A 2-stage dividend discount model gives the firm a mere 23% upside from current values.
Those with 10-year time horizons might not care. With a 32% ROIC and a 30% reinvestment ratio, the company could theoretically increase its intrinsic value by 150% and simultaneously buy back a quarter of its shares over a decade.
But 2022’s stock pullback has created even better opportunities for investors willing to take more risk. Though companies like ALGN might be a wilder ride, it’s bets like these that can add large returns while keeping a margin of safety.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.
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