Is DexCom a million dollar stock?

Medical device specialist DexCom (DXCM -0.40%) going through a hard time. The company’s stock fell off a cliff following its second-quarter earnings report. However, zooming out helps put things into perspective. The healthcare company has generally delivered well above average returns. Can DexCom keep doing this long enough to be a millionaire stock for investors getting in today? Let’s find out.

What DexCom does

DexCom is the market leader in continuous glucose monitoring (CGM) systems, devices that allow diabetics to keep track of their blood glucose levels. This field is basically a duopoly with which DexCom shares Abbott Laboratories. CGMs are better mousetraps than hand-operated blood glucose meters, which can only indicate a person’s sugar level at any given time. CGMs do this automatically and continuously throughout the day. They can also be paired with pumps to automate the insulin delivery process. Many studies have concluded that CGMs help diabetes patients achieve better health outcomes.

DexCom was successful precisely because it helped increase the adoption of this technology. Revenue, earnings and stock performance have been impressive, if a little volatile, since the 2005 IPO.

DXCM Total Return Level data by YCharts.

Note that a $50,000 investment in DexCom at the IPO would be worth more than $1 million today.

The opportunities

Is there enough growth fuel left? Globally, yes. DexCom and Abbott labs have barely scratched the surface of the global diabetes market. Of the half a billion adults with diabetes, only 1% use CGM technology. The problem with DexCom is that most of these patients are in second and third world countries where it doesn’t work. However, its addressable market should expand as it enters more regions. That’s what DexCom has done in the past. In addition, the company builds a competitive advantage through the network effect.

DexCom’s CGM devices are compatible with other gadgets and apps. Devices compatible with the DexCom G6, G7 or DexCom ONE include Tandem diabetes care t:slim X2, Island Omnipod 5, some of the Eli Lillyhis and Novo Nordiskhis insulin pens and Apple Clock. Glooko, a privately held company that provides digital health solutions for diabetes patients, also works with DexCom. The more patients in DexCom’s installed CGM customer base, the more attractive it is for other companies to make their diabetes-focused products and services compatible with DexCom’s.

So new entrants will have a hard time prying customers away from DexCom. And while another company might create a better CGM device, DexCom has proven incredibly innovative. Its newest G7 is the most accurate CGM on the market.

risks

Several things could derail DexCom’s long-term plans. For example, some drug manufacturers are working on potential functional remedies for type 1 diabetes. The list includes Vertex Pharmaceuticals and CRISPR Therapeutics. Data from an ongoing Phase 1/2 study show that patients treated with VX-880 Vertex showed improvements, including glucose-responsive insulin production by day 90 (people with type 1 diabetes typically do not produce insulin ). Three of them, who had more than a year of follow-up, showed insulin independence.

This is great news for Vertex and these patients. If these efforts are successful, DexCom’s addressable market could shrink, though not by much. The vast majority of people with diabetes — 90 percent to 95 percent in the U.S. — have type 2. That’s something to keep in mind, though. Elsewhere, Apple has been trying to develop a CGM option within its smartwatch, something else that could undermine DexCom’s business given Apple’s massive brand power and installed base. However, these efforts appear to be in the early stages and it is not known whether they will be successful.

Finally, DexCom stock looks expensive.

DXCM PE report data (before) by YCharts.

At the time of writing, the healthcare industry’s average forward price-to-earnings ratio is 19.5. However, how much will this matter 10 years from now? Probably not much.

verdict

DexCom’s recent decline was due to short-term issues, including patients taking advantage of discounts more than anticipated and slower-than-hoped-for G7 adoption. These headwinds will subside, and the stock still has incredibly attractive long-term prospects. DexCom may not perform as well over the next 20 years as it did in 2005, but it can still help patient investors become millionaires. However, ‘Patient’ is the key word as this will not happen overnight.