The coronavirus pandemic has made winners and losers out of many stocks. Most of the companies that have performed well could have been predicted: Stocks that facilitate remote work and online commerce have flourished. But many of those that rely on in-person interaction have been left behind.

That's why I find it so surprising that Align Technology (NASDAQ:ALGN) beat this trend. After quickly adapting to the pandemic and finding a way to keep its teeth-straightening systems flowing, will management be able to maintain the growth as the number of confirmed coronavirus cases rises across the country?

A woman putting clear teeth aligners in her mouth.

Image source: Getty Images.

The business model

On its most basic level, Align's business model links together hardware and software to facilitate the sale of consumables. The company's Invisalign teeth straighteners are its bread and butter. In 2019 alone, more than 1.5 million people started treatment with the company's clear aligners. Its iTero scanners and software are used to map the structure of the teeth and gums, and visualize changes over time. For restorative dentistry, the company's exocad software helps design dental prosthetics and implants. These all work in concert to provide patients with the best path to a healthy smile. 

The doctor-driven model relies on orthodontists and, to a lesser extent, general-practitioner dentists to recommend and provide the clear aligners. The company invests a lot of time and effort into making sure the doctors benefit from the partnership. Invisalign takes less time per patient to straighten teeth so more patients can be seen, and the company also trains orthodontists so that they can be more efficient.

Align spends a considerable amount on marketing to keep a steady stream of new patients ready to begin the journey. A key metric for management is utilization -- the number of case shipments per orthodontist. Clearly, the formula is working: Annual utilization has consistently grown since 2016.

Year Cases per Orthodontist
2016 36.6
2017 46.6
2018 56.7
2019 65.0

Source: Align 2020 Investor Day Presentation. Table by author.

The pandemic has brought the future closer

As the pandemic took hold in late spring, Microsoft CEO Satya Nadella said the company had experienced two years of digital transformation in two months. He was talking about software, but he could very well have been talking about Align's approach to orthodontics. The company responded to the 41% drop in sales during the second quarter with virtual tools and training, as well as efforts to help more dentists go digital. The result was a record $733 million in revenue in the quarter ending Sept. 30.

Although pent-up demand and digital tools played a large role, CEO Joe Hogan offered another surprising explanation for some of the growth: people spending more time on teleconferences critiquing themselves on camera. Since traditional braces are an analog solution -- unlike the digital scanning and software-enabled designs Align facilitates -- many orthodontists and general practitioners switched to the company's clear aligners as a way to keep seeing patients. The company also rolled out the MyInvisalign mobile application in 40 countries to support the virtual care necessitated by COVID-19 restrictions.

Can the fundamentals support the valuation?

Unfortunately for investors, shares have more than recovered from the 50% drop earlier this year. In fact, Align stock is up 84% in 2020 and almost 265% from March lows. Management still hasn't provided guidance for 2020 or 2021, but it's clear that investors are pricing in a future even more spectacular than the pre-COVID past. The company believes the addressable market for its clear aligners is about 500 million people globally. That's several orders of magnitude greater than the 1.5 million helped last year. But is the growth already priced into shares? Currently, the stock trades at an unbelievable forward price-to-earnings (P/E) ratio of 111 -- its highest ever.

ALGN PE Ratio (Forward) Chart

ALGN PE Ratio (Forward) data by YCharts

In some ways, this signals higher growth expectations for the business than ever before. But where do those expectations come from? Sales were up 21% in the third quarter: good, but not on pace with past years. Perhaps the pandemic validated the company's digital workflow as a strategic advantage that will endure long after COVID-19 is just a memory. The largest competitor in the clear-aligner space, SmileDirectClub (NASDAQ:SDC), is only one-tenth the size of Align.

Whatever the reason, Align is a marvelous business that should go on investors' short lists the next time a market disruption provides a buying opportunity. For now, I think shares need to come back down to earth before they're attractive.