Investing in Diabetes Stocks: A Beginner's Guide

Roughly 1 out of every 10 Americans -- or more than 30 million people -- have diabetes. Another 84 million Americans have prediabetes, which means they are dangerously close to developing diabetes.

The numbers get even more mind-boggling when you zoom out to include the rest of the world. The World Health Organization estimated that more than 422 million people had diabetes in 2014. Millions more are diagnosed every year. These numbers show why many healthcare experts consider diabetes to be an epidemic. 

Image source: Getty Images.

Treating diabetes is enormously expensive. A study published in the medical journal The Lancet in 2016 estimated the global cost of diabetes is more than $825 billion per year.

Given these numbers, it should come as no surprise to see that treating diabetes has turned into a big business. Below, we'll take a look at everything that investors need to know about how to put money to work in the disease state.

What is diabetes?

Diabetes occurs when the body loses its ability to properly regulate glucose levels in the blood. That's a big problem because glucose is the body's main source of fuel.

Maintaining healthy glucose levels is a delicate balancing act that is normally managed by the liver and the pancreas. Too little glucose in the blood -- which is called hypoglycemia -- can lead to dizziness, fainting, and even death in extreme cases. On the flip side, too much glucose in the blood -- which is known as hyperglycemia -- isn't good either. Excess glucose can damage major organs, such as the kidneys, heart, and eyes. 

Normally, the pancreas combats rising glucose levels by releasing insulin into the bloodstream. Insulin is a hormone that enables cells to convert glucose into energy. However, people with diabetes either no longer make enough insulin to satisfy their needs or they have lost the ability to use the insulin their bodies produce effectively. 

Broadly speaking, there are three main types of diabetes:

• Type 1: This type of diabetes occurs when the immune system mistakenly attacks and destroys its own insulin-producing cells in the pancreas. While Type 1 diabetes can occur at any age, it usually happens in children and young adults. That's why it used to be referred to as "juvenile diabetes" for many years . However, that terminology has since been dropped since adults can be diagnosed with Type 1, too. With Type 1 diabetes, a person no longer makes any insulin at all and must regularly receive artificial insulin in order to stay alive. Only about 5% all people with diabetes have Type 1.
• Type 2: This type of diabetes occurs when the body no longer makes enough insulin to meet its needs or fails to utilize the insulin that is produced naturally effectively. Type 2 diabetes can also occur at any age, but is most commonly diagnosed in middle-aged people and senior citizens. There is also a strong link between obesity and Type 2 diabetes. Type 2 is by far the most common form of diabetes.
• Gestational diabetes: This type of diabetes occurs in some women when they become pregnant. Thankfully, gestational diabetes usually disappears after the baby is delivered. However, patients with gestational diabetes are often at a greater risk of being diagnosed with Type 2 diabetes down the road. In addition, sometimes patients are mistakenly diagnosed with gestational diabetes when in fact they actually have Type 2 diabetes.

Treating diabetes

All people who have Type 1 diabetes and gestational diabetes require treatment. Most patients with Type 2 diabetes receive regular care as well.

Here's an overview of the tools and methods that are used in modern-day diabetes management:

• Glucose monitoring: People with diabetes need to constantly monitor their blood glucose levels to ensure that they are in a healthy range. Most patients track their levels by using a meter that provides a point-in-time reading when a drop of blood is applied to a disposable strip (the blood is usually obtained from a finger prick). In recent years several companies have introduced continuous glucose monitors that track blood sugar levels directly in real time.
• Diet and exercise: Many people with Type 2 diabetes can keep their blood sugar levels in a healthy range by adopting a lifestyle that features healthy eating habits and regular exercise. 
• Medication: A huge variety of drugs are available to help people with Type 2 diabetes reach their goals when dieting and exercising alone is not enough. Some of these drugs lower blood glucose levels by increasing the body's sensitivity to insulin (such as metformin and thiazolidinediones). Other drugs work by stimulating the pancreas to increase its insulin production (sulfonylureas and meglitinides). Some other drugs help to slow digestion and reduce blood sugar spikes after meals (DPP-4 inhibitors and GLP-1 receptor agonists). The newest generation of diabetes drugs helps the body to excrete more glucose through urine (SGLT2 inhibitors).
• Insulin: Every patient with Type 1 diabetes and many patients with Type 2 diabetes need artificial insulin to control their blood sugar levels. The majority of patients who take insulin inject it into their body by using a syringe or insulin pen. However, some patients choose to get insulin delivery by using a pump. Insulin pumps came in a variety of styles but are generally worn continuously and infuse insulin directly into the patient's body.  

Companies that make diabetes products

A multitude of private and public companies make products that are used to treat diabetes.

Here's are some of the biggest and best-know publicly traded diabetes companies:

DATA SOURCE: YAHOO! FINANCE. MARKET CAP DATA AS OF 9/25/2018. 

You've likely noticed that several of these are massive healthcare companies. Johnson & Johnson, Sanofi, and Medtronic all boast market capitalization in excess of $100 billion and sell products in a multitude of disease states, including diabetes. That's why many of them are not great options for investors who want to buy pure-play diabetes companies. For example, Medtronic's diabetes division should pull in about $2 billion in annual revenue in fiscal 2018 from the sale of insulin pumps and continuous glucose monitors. While that's a big number in absolute terms, it makes up only about 6% of the company's total sales. Investors who are looking for direct exposure to the diabetes market are probably better served by looking elsewhere.

So which diabetes companies are the top stocks for investors? Here's a closer look at three companies that I believe are worthy of consideration.

Novo Nordisk

You'd be forgiven if you assumed that Novo Nordisk, with a market cap of $116 billion, is a giant drugmaker that has its hands in several different disease states. In fact, the overwhelming majority of Novo's revenue comes from selling drugs that treat diabetes. In 2017, diabetes products sales comprised 81% of Novo's top line, which makes it as close to a pure play on diabetes as it gets in big pharma.

Novo sells a number of popular drugs that are used to treat all three types of diabetes. Its insulin business sells brand-name products such as NovoLog, Tresiba, Levemir, Xultophy, and Fiasp. While all of the company's insulins lower glucose levels, they differ in how quickly they reduce glucose levels, their maximum impact, and how long they remain active in the body. Novo also markets a number of branded medicines that are used to treat Type 2 diabetes, such as NovoNorm, Ozempic, and Victoza.

Novo's focus on diabetes has made it a wonderful stock to own for many years. However, the last few years have been a challenging time for the business. U.S. insurers have put a tremendous amount of pressure on the company to reduce prices on its insulin products in order to maintain favorable formulary coverage. That pricing pressure became so great that management eventually dialed back its long-term growth rate projections in 2016.

More recently, Novo's business has been on an upswing thanks to several successful drug launches. Expense control and label expansion claims have also helped the company to move its bottom line in the right direction. 

Novo's profits should continue to lurch forward at a modest rate as next-generation drugs from its pipeline are steadily introduced to the market. While this company probably won't be posting fast growth anytime soon, it remains a low-risk way for investors to beef up their diabetes exposure. Income investor will also like that Novo pays out a dividend yield of about 2.8%.

Insulet Corporation

Insulin pumps are a great tool for insulin-dependent diabetes patients to control their glucose levels. Insulin pumps have been around for decades, and they work by delivering fast-acting insulin into a patient's body 24 hours a day. Modern pumps can be programmed to deliver different amounts of insulin at different times of the day to more closely match a patient's needs. At mealtime, patients can give themselves additional insulin to control their blood sugar spikes.

While insulin pumps can greatly help a patient to manage their diabetes, only a minority of patients use them. One reason for the disconnect is that the majority of insulin pumps require patients to wear tubing. That's an unappealing prospect for many patients because tubing can easily get snagged or tangled with everyday activities. 

Insulet's solution to this lifestyle problem was to launch a patch pump that is worn directly on the body. This unique device is called the Omnipod, and it has been a huge hit with patients ever since it was launched for sale in 2005.

For investors, the beauty of Insulet's Omnipod System is that the patch portion of the pump needs to be replaced every three days. This razor-and-blade business model -- which is a strategy that involves first selling a durable product (razor) to help drive sales of a consumable product (blades) -- makes the company's revenue highly predictable as new users adopt the system. 

Insulet has also innovated new uses for its drug delivery technology. The company has a partnership in place with Amgen in which the Omnipod is used to deliver the cancer drug Neulasta to patients. The company also continues to explore other drugs that may benefit from its tubing-free delivery system. 

Between its diabetes and other drug business, Insulet's CEO is calling for the company's revenue to exceed $1 billion by 2021. That's more than double what the company produced in 2017. If Insulet can deliver on its ambitious growth targets, then it is likely that its share price will continue to rally.

Dexcom

DexCom has been a red-hot growth stock ever since it won approval for its first continuous glucose-monitoring system back in 2006. This innovative device allowed patients with diabetes to track their blood sugar levels in near real time, making it much easier for them to stay within a healthy range.

DexCom has made several important improvements to its product over the years, including the recent FDA approval of its sixth-generation system. This newest product enables patients to make therapy decisions without having to prick their finger, and it's the first DexCom product to win such a claim. This innovative product should allow the company's ultra-fast revenue growth rate to continue. 

Another potential positive for investors is that DexCom has struck up numerous partnership agreements with insulin pump manufacturers such as Insulet and Tandem Diabetes Care. The aim of these agreements is to eventually introduce an artificial pancreas to market. An artificial pancreas would continuously sense a patient's blood glucose level and automatically dose insulin into the body. This would keep a patient's glucose levels in a healthy range at all times without any input at all from the patient. If achieved, this technology promises to revolutionize diabetes care. 

Like Insulet, DexCom operates using a razor-and-blade business model. This helps to ensure that the company's revenue will continue to grow over time as more users make the switch.

DexCom estimates that 6 million patients in the U.S. and EU alone are on intensive insulin therapy. However, less than 10% of them are currently using a continuous glucose-monitoring system. That provides the company with a tremendous runway for growth even as competition in the space continues to heat up.

Should you invest in diabetes stocks?

It's an unfortunate truth that diabetes is one of the fastest-growing diseases in the world. The number of patients with diabetes has increased by nearly fourfold since 1980. If current trends persist, the number of people with diabetes is expected to exceed 640 million by 2040 with 150 million of them living in China alone.

While the opportunity ahead is huge, there are risks for investors to consider. Regulators have to give the thumbs-up to devices and drugs before they can be marketed, but approvals aren't always guaranteed. Pharmaceutical sales can also evaporate when a drug loses patent protection and a cheaper generic version of the drug is launched. That risk now exists for biologic drugs, too, now that biosimilars -- copycat drugs that are made inside a living organism -- have been given the go-ahead in the U.S. Also, competition has been heating up in the disease state, which gives governments and insurers firepower to negotiate pricing concessions. 

Given these risks, diabetes investors shouldn't place all of their chips on a single stock. Instead, taking a basket approach makes sense. A long-term time horizon is also required since many of these stocks can be highly volatile.  

Until a cure is finally invented, the best option for many patients with diabetes is to manage their disease by using the most effective diabetes products and treatments. That puts innovative companies like Novo Nordisk, Insulet, and DexCom in a great position to continue delivering for shareholders and patients alike.