Where there's a problem, there's an opportunity.

Diabetes certainly presents a huge problem. It's the seventh-highest cause of death in the United States. It's also one of the fastest-growing diseases: At 29 million, the number of people in the U.S. with diabetes is nearly triple the number 20 years ago. And the problem isn't limited to the U.S.; diabetes is also the fastest-growing chronic disease in the world.

Many publicly traded companies, both large and small, are developing new drugs and medical devices for diabetes care. The opportunities for investors lie in buying the stocks of the companies most likely to succeed in the growing diabetes market. Here's what you need to know about how to invest in diabetes stocks.

Physician holding card with "diabetes" written on it

Image source: Getty Images.

What is diabetes?

Before investing in diabetes stocks, it's important to understand exactly what diabetes is: a common disease that occurs when individuals' blood glucose ("blood sugar") levels become too high.

Glucose enters the bloodstream from food. Normally, insulin, a hormone produced by the pancreas, helps make sure the glucose moves from the blood to cells, to provide energy for those cells. But when the body doesn't make enough insulin -- or doesn't use it properly -- glucose stays in the blood rather than reaching the cells. If not managed, diabetes can lead to several serious health problems; these include eye problems, dental disease, foot problems, heart disease, kidney disease, nerve damage, and stroke.

The A1C test is the most frequently used method of testing for diabetes. It's a blood test that measures the amount of hemoglobin -- a protein in blood that carries oxygen -- with attached glucose. The measurement reflects the patient's average blood glucose levels over the previous three months. A1C levels are reported as a percentage, with a higher percentage representing higher blood glucose levels. Individuals with diabetes have A1C levels of 6.5% or higher.

How big is the diabetic population?

More than 30 million Americans have diabetes, according to the Centers for Disease Control and Prevention (CDC). Another 84 million have prediabetes -- where blood glucose levels are high (between 5.7% and 6.4%) but not high enough to be considered diabetes. Prediabetes is a risk factor for diabetes, and the higher the patient's A1C level is, the greater the risk.

Types of diabetes

There are three common types of diabetes, along with other less common types of the disease.

Type 1 diabetes

With type 1 diabetes, the body doesn't make insulin at all. Most frequently this is because the immune system attacks cells in the pancreas that produce insulin. Patients with this type of diabetes must take insulin every day to live. Around 1.25 million Americans have type 1 diabetes, with the disease typically diagnosed in children and young adults.

Type 2 diabetes

The most common form of diabetes is type 2 diabetes. With this type, the body either doesn't produce enough insulin, or doesn't use it very well. Type 2 diabetes can be caused by several factors, including lack of physical activity, being overweight, insulin resistance, and genetics. Around 28 million Americans have this form of the disease.

Gestational diabetes

Gestational diabetes occurs in 2% to 10% of pregnant women in the U.S. Changes during pregnancy, such as increased production of hormones and weight gain, cause the body to use insulin less effectively; as a result, the body can't make enough insulin. Around 50% of women with gestational diabetes go on to develop type 2 diabetes.

Other types of diabetes

Two other less common types of the disease are monogenic diabetes and cystic-fibrosis-related diabetes. "Monogenic" diabetes results from changes in a single gene (the more common forms are "polygenic"); this type accounts for 1% to 4% of all cases of diabetes.

Cystic-fibrosis-related diabetes (CFRD) occurs when the thick, sticky mucus associated with cystic fibrosis (a genetic disease) causes scarring of the pancreas. This scarring results in the pancreas being unable to make enough insulin. More than 30,000 Americans have cystic fibrosis, with 20% of adolescents with the disease also suffering from CFRD and between 40% and 50% of the adults having CFRD.

How is diabetes treated?

Some cases of Type 2 diabetes can be managed through diet and exercise. However, type 1 diabetes and many cases of type 2 diabetes require more involved treatment. There are several components that can be part of managing and treating diabetes.

Glucose monitoring

Monitoring glucose levels is critical for both type 1 and type 2 diabetic patients.

Individuals with type 1 diabetes typically must check their glucose levels four to 10 times per day, including prior to eating, before and after exercise, and before going to sleep. Some type 1 patients must also check their glucose levels during the night. Also, some people with type 1 diabetes use continuous glucose monitors (CGMs), devices with sensors beneath the skin that check blood glucose levels every few minutes.

Type 2 diabetic patients usually must monitor their glucose levels at least twice each day -- before breakfast and dinner. Some individuals with type 2 diabetes must check their glucose levels before each meal and at bedtime.

Insulin

All type 1 diabetic patients and many type 2 diabetic patients must take insulin. There are four key types of insulin:

Type

How fast the insulin begins to work

Period when the insulin is most effective

How long the insulin works

Rapid-acting 15 minutes after injection ~1 hour 2-4 hours
Short-acting 30 minutes after injection 2-3 hours 3-6 hours
Intermediate-acting 2-4 hours after injection 4-12 hours 12-18 hours
Long-acting Up to 4 hours after injection Lowers glucose levels relatively evenly with minimal peak Up to 24 hours

Data source: American Diabetes Association.

Insulin can be administered using a variety of devices:

  • Needle and syringe
  • Insulin pen (an easy-to-use penlike device for self-injection)
  • Insulin pump (a small device that delivers regular small doses, and higher doses when needed)
  • Inhaler
  • Injection port (a short tube inserted beneath the skin)
  • Jet injector (a high-pressure insulin spray)

Other medications

Some type 2 diabetic patients also are prescribed non-insulin medications. Common types of diabetes medications include:

Type of drug

How the drugs work

Examples

Sulfonylureas

Stimulate beta cells in the pancreas to produce more insulin Diabinese, Glucotrol, Micronase
Biguanides Decrease the amount of glucose produced by the liver Metformin
Meglitinides Stimulate beta cells in the pancreas to produce more insulin Prandin, Starlix
Thiazolidinediones Make insulin more effective and decrease the amount of glucose produced by the liver Avandia, Actos
DPP-4 inhibitors Prevent the breakdown of GLP-1, a peptide that reduces blood glucose levels Januvia, Onglyza, Tradjenta
SGLT2 inhibitors Help the kidneys reabsorb glucose Invokana, Farxiga, Jardiance
Alpha-glucosidase inhibitors Prevent the breakdown of starches, thereby reducing glucose levels Glyset, Precose

Data source: American Diabetes Association.

Factors driving the diabetes market

By 2030, diabetes is projected to affect nearly 55 million Americans and 552 million people worldwide. In the U.S., total annual medical and societal costs related to diabetes are projected to increase by 53% to more than $622 billion. And the global total direct and indirect cost of diabetes is estimated to almost double by 2030 to $2.5 trillion.

Several factors are driving growth in the diabetic patient population and increased spending on diabetes.

1. Aging populations

One key trend that will likely increase the number of cases of diabetes is the growth in senior populations across the world. As people age, they're less likely to get enough exercise, which can result in added weight -- both of which are key factors that can contribute to type 2 diabetes.

2. Lower levels of physical activity in youth

Not just the older part of the population is a cause for concern. Children and adolescents are also getting less physical activity, which has already led to a higher prevalence of type 2 diabetes in youth. Only one in three U.S. children is physically active every day, according to the U.S. Department of Health and Human Services. Children spend more than seven and a half hours a day, on average, in front of a computer, smartphone, TV, or video game screen.

3. Developing nations adopting Western lifestyles

Another driver of greater diabetes prevalence comes from developing countries. As the middle classes expand in these nations, their citizens are more likely to adopt lifestyles associated with the Western world, including unhealthy diets and less exercise.

4. New drugs and devices for managing diabetes

Obviously, the increased numbers of patients diagnosed with diabetes will play a key role in higher costs. Ironically, better treatments for diabetes are also anticipated to contribute by prolonging the lives of patients with diabetes, which increases the costs over the long run of managing their related health problems. In addition, new drugs and devices for managing diabetes are more expensive than older products, driving costs up even more.

Woman on couch testing her glucose levels

Image source: Getty Images.

Diabetes stocks

Diabetes stocks fall into three broad categories: Drugmakers, medical-device makers, and companies that market medical supplies for diabetes. Below is a list of diabetes stocks with market caps of at least $200 million.

Company

Category

Market Cap

Forward P/E

Dividend Yield

Abbott Laboratories (NYSE:ABT) Drugs $109 billion 19.37 1.88%
AstraZeneca (NYSE: AZN) Drugs $93 billion 19.70 3.97%
Becton Dickinson and Co. (NYSE: BDX) Medical supplies $60 billion 17.74 1.29%
DexCom (NASDAQ: DXCM) Medical devices $8 billion N/A N/A
Eli Lilly and Co. (NYSE: LLY) Drugs $85 billion 14.91 2.77%
Insulet (NASDAQ: PODD) Medical devices $5 billion 273.03 N/A
Johnson & Johnson (NYSE: JNJ) Drugs, medical devices $325 billion 14.16 2.57%
Lexicon Pharmaceuticals (NASDAQ:LXRX) Drugs $1 billion N/A N/A
MannKind (NASDAQ: MNKD) Drugs $270 million N/A N/A
Medtronic (NYSE: MDT) Medical devices $117 billion 15.36 2.14%
Merck & Co. (NYSE: MRK) Drugs $159 billion 12.99 3.22%
Novo Nordisk (NYSE:NVO) Drugs $116 billion 18.29 2.61%
Pfizer (NYSE: PFE) Drugs $209 billion 11.62 3.82%
Regeneron Pharmaceuticals (NASDAQ: REGN) Drugs $32 billion 13.95 N/A
Sanofi (NYSE: SNY) Drugs $95 billion 10.75 4.64%
Senseonics Holdings (NYSEMKT: SENS) Medical devices $447 million N/A N/A
Tandem Diabetes Care (NASDAQ: TNDM) Medical devices $711 million N/A N/A

Data source: Yahoo! Finance. P/E = price-to-earnings ratio; N/A = not applicable. Data as of May 25, 2018.

Factors to consider in evaluating diabetes stocks

What should you look for in a diabetes stock? Well, for starters, you'll want to evaluate the company just as you'd research any potential investment. Key factors to consider include:

1. Diabetes products' contribution to total revenue

How significant is the diabetes market to the company? A company that makes most of its revenue in other ways won't benefit as much from the growth in the diabetes market.

Pfizer, for example, co-markets new diabetes drugs Steglatro, Steglujan, and Segluromet with Merck. But those are the only diabetes drugs in Pfizer's lineup; although they're expected to become a blockbuster franchise for the two companies, diabetes will still represent only a small portion of Pfizer's overall revenue.

If you are looking to put money behind the diabetes market specifically, investing in a stock like Pfizer might not be your best bet. Buying a pure-play stock like Senseonics gives you greater exposure to the diabetes market, but it's also riskier than a diversified company like Pfizer. If this market doesn't grow as quickly as projected, it would have a much greater negative impact on Senseonics than it would Pfizer.

2. Competitive advantages and risks

Although the diabetes market is huge, it's still very competitive. Companies that enjoy competitive advantages stand a better chance of long-term success.

However, even successful products face the risk of losing market share to a rival. When brand-name drugs lose patent exclusivity, other companies can launch cheaper generic versions of the drug. With a biologic drug -- one made from a living organism or its products -- rivals can launch knockoff biosimilars after it loses patent exclusivity.

Of course, a drug doesn't have to have its patents expire to lose market share. New drugs can come on the scene that are more effective, safer, and/or less costly.

3. Development risks

The drug development process is risky. This process begins with preclinical testing in animals. If that testing goes well, approval must be obtained from regulators to advance to testing in humans.

There are usually three phases of clinical testing of a new drug in humans. Phase 1 typically involves only a few patients and focuses on assessing the safety of the drug. Phase 2 includes more patients and evaluates the efficacy of the drug in addition to safety. Phase 3 clinical studies are usually much larger and take more time -- often between one and four years. These phase 3 studies focus on efficacy and potential adverse reactions. If drugs are shown to be successful in clinical testing, drugmakers submit for regulatory approval by the U.S. Food and Drug Administration (FDA) and similar agencies in other countries.

Each step in this process holds the potential for failure. For every 10 drug candidates that start in phase 1 clinical studies, on average only one will make it all the way to approval.

The process for winning approval for new medical devices targeting diabetes care also requires several hurdles to be jumped. Companies must first test prototypes of the new medical devices in controlled settings that don't involve humans. The pathway to approval then depends on the risk that the device presents. Devices that hold significant risks for patients must go through clinical trials and FDA review similar to that for new drugs. There's no guarantee that a new medical device will be cleared for marketing by the FDA.

So what should investors do about these development risks? Choosing stocks with pipeline candidates in late-stage development is less risky than picking stocks with early-stage drugs. Also, companies with more pipeline candidates have more "shots on goal," which improves the overall chances of success.

4. Reimbursement risks

Once a drug or medical device wins regulatory approval, there's another challenge: securing reimbursement. In the U.S., pharmaceutical and medical-device companies must negotiate with health insurers to get their products covered for reimbursement. Drugmakers also have to negotiate with pharmacy benefits managers (PBMs) -- third-party administrators of programs that attempt to control prescription drug costs for their customers. In Europe, where universal healthcare plans are paid for by national governments, companies must negotiate pricing on a country-by-country basis.

It's possible that a new product can get a green light from regulatory agencies but not win favor with payers. Even if a product does secure reimbursement coverage, there's no guarantee that the desired price will be negotiated. Payers can also put additional obstacles in the way, such as mandating that patients obtain prior authorization before using a new product. All of this is to say that just because a new product is approved, that doesn't mean you can count on it succeeding commercially.

Top diabetes stocks to consider

So in light of these key factors and risks, what are the best diabetes stocks to consider? I think three especially stand out.

Abbott Labs

Although Abbott Labs doesn't currently detail how much of its revenue is generated from diabetes-care products, diabetes is becoming an increasingly important growth driver for the company. This new dynamic is primarily the result of FDA approval in September 2017 for Abbott's new flash glucose monitoring system FreeStyle Libre.

It's important for many diabetic patients to continuously monitor their blood glucose levels. The drawback to most continuous glucose monitoring (CGM) systems is that they require patients to calibrate the systems by sticking their fingers several times per day to test blood glucose levels.

FreeStyle Libre eliminates the need for those pesky finger sticks, and has a much lower cost than most CGM systems. As you might imagine, those are significant competitive advantages for Abbott. Dexcom recently launched its G6 CGM system that doesn't require finger sticks, but it's more expensive than the FreeStyle Libre.

Abbott Labs is highly unlikely to need to raise any cash by issuing more stock: The company reported more than $4 billion in cash, cash equivalents, and marketable securities at the end of the first quarter. Abbott also has one of the most stable dividends around, with the company paying a dividend every quarter since 1924 and increasing its dividend payout for 46 consecutive years -- making it a longtime member of the elite Dividend Aristocrats.

Lexicon Pharmaceuticals

Lexicon Pharmaceuticals is considerably more risky than Abbott Labs. The company only has one FDA-approved product right now -- Xermelo, for carcinoid syndrome diarrhea; the drug launched in the first quarter of 2017. Lexicon awaits regulatory approval for its first diabetes drug, sotagliflozin.

So why consider buying Lexicon stock? Wall Street analysts think it could be one of the fastest-growing diabetes stocks on the market this year. That's for good reason: If approved, sotagliflozin will be the first combination SGLT1/SGLT2 inhibitor.

SGLT2 (SGLT stands for "sodium-glucose linked transporter," and the numbers denote the type of cotransporter) is responsible for most of the glucose reabsorption performed by the kidneys. SGLT1 is responsible for glucose absorption in the gastrointestinal tract, and, to a lesser extent than SGLT2, glucose reabsorption in the kidneys. Sotagliflozin could be a huge winner because it's potentially more effective than SGLT2 inhibitors such as Invokana and Jardiance. As an added bonus, it treats both type 1 and type 2 diabetes.

Novo Nordisk

Novo Nordisk ranks as one of the leaders in the diabetes drug market. The Danish drugmaker's insulin products Levemir, Tresiba, NovoMix, and NovoRapid are huge moneymakers. But the main reason I like Novo Nordisk is the company's newer products.

The FDA granted approval to type 2 diabetes drug Ozempic in December. Market research firm EvaluatePharma thinks that Ozempic will be the second-biggest new drug launched in 2018, with more than $2.7 billion in annual sales by 2022. I also like the prospects for Novo's obesity drug Saxenda, which I see as a great fit with the company's diabetes lineup.

Don't forget Novo Nordisk's dividend, either. Over the last 10 years, investors received an additional 78% in total returns thanks to the drugmaker's dividend. And with a payout ratio of less than 50%, Novo has plenty of flexibility for dividend hikes in the future.

Unmet opportunities

There are also two unmet opportunities in diabetes that investors should be aware of.

One is in new products that help prevent the disease. Type 2 diabetes is largely preventable through diet and exercise. New superfoods created by gene editing could be game-changers down the road, helping people avoid gaining extra weight that could make them more likely to develop diabetes.

Another is in more convenient ways to monitor glucose levels. Abbott's FreeStyle Libre is a fantastic innovation on this front, but more advances could be on the way. For example, Alphabet's Verily Life Sciences unit is working with Novartis to develop a smart contact lens that senses glucose levels in tears. These contact lenses would change color if diabetic patients' glucose levels aren't where they need to be.

Such developments are likely years down the road, at best. But diabetes is such a huge problem that making these technologies become reality should be worth the effort.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Keith Speights owns shares of Alphabet (A shares) and Pfizer. The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool owns shares of Johnson & Johnson and Medtronic. The Motley Fool recommends Becton Dickinson, Insulet, and Novo Nordisk. The Motley Fool has a disclosure policy.