In this week's episode of Industry Focus: Healthcare, host Shannon Jones talks with Motley Fool medtech guru Brian Feroldi about three earnings reports from three fantastic medtech companies: Guardant (NASDAQ:GH), the leader in liquid biopsies, and the game-changing diabetes players Dexcom (NASDAQ:DXCM) and Insulet (NASDAQ:PODD). Tune in to find out what each of these companies does and why it's so good for patients and business, how they performed this quarter, some of the biggest risks and competitive threats to look out for, what kind of growth runways they have ahead of them, which one looks like the most appealing buy for long-term investors today, and much more.

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This video was recorded on Nov. 13, 2019.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every single day. Today is Wednesday, November the 13th, and we're talking healthcare. I'm your host, Shannon Jones, and I am joined via Skype by fool.com's health and tech specialist, Brian Feroldi. Brian, how's it going?

Brian Feroldi: Hey, Shannon! We are in the throes of earnings season, although it is coming to a close. This is one of my favorite times of year. I just love getting the nonstop information. It was awesome to see you in person last week. I really enjoyed my trip down to the Fool.

Jones: Yeah, always good to have you here at the Fool, especially in the midst of earnings season. Yeah, you're right. Earnings season to me, you've got so many shocks, surprises, disappointments. It really takes you through the entire loop of all of your emotions within a few short weeks. So I'm excited for today's show, because we're going to be talking about three notable healthcare companies that recently posted some blowout earnings results. We've covered all three on the show before. Of course, at the end, we're going to reveal basically which one is our top pick. 

Let's kick things off here, Brian, let's do the first earnings report coming from Guardant Health, that's ticker symbol GH. This is a company whose mission statement is a simple yet very profound one, Brian. It's very simply conquering cancer with data. What in the world does that actually mean, though?

Feroldi: This is a fascinating company that came public less than a year ago and it's just been on fire for investors. Guardant Health is a leading provider of liquid biopsies. The company's technology is able to detect cancer from a simple blood draw, instead of the traditional way to diagnose types of cancer is with a sample, so you have to go in and actually get a biopsy of the tumor. By contrast, Guardant enables clinicians to diagnose cancer from just a simple blood draw, which has so many benefits. The big one for patients is, it's way less invasive. Some cancers actually, you have to set a patient under anesthesia to get it diagnosed, which is just a huge pain for them. It's also very expensive. Guardant's technology can diagnose lung cancer for about $3,500, something like that. By contrast, a traditional lung biopsy costs about $14,000. So not only is it better on the patient, but it's also much less costly. This technology is groundbreaking.

Jones: Yeah, in more ways than one. It's also safer. For a lot of these solid tumors, when you have to go in and do a biopsy, there is a chance that you disturb the tumor and cells can then escape and go throughout the body and cause cancer in other places that it didn't originally start. Having the ability to do these liquid biopsies really is innovative. But at the heart of it is really the fact that we're talking about precision medicine. With a company like Guardant, and there are many others that are now coming in this space, it's about getting the right treatment to the right patient. Really, where I think you're starting to see Guardant is really focusing on how can we do that sooner and earlier in the process for cancer patients? We'll talk a little bit about that in a second. But, cancer in and of itself, second leading cause of death around the globe. By 2030, researchers are expecting 21 million new cases every single year. The market opportunity for a company like Guardant is huge, and it's no wonder why the stock has taken off. I was just looking year to date, the stock is up 98%, which is pretty astounding. Up 8% just off of Q3 earnings. What did we see for their Q3, Brian?

Feroldi: Guardant just knocked the cover off the ball in the third quarter. Revenue growth has been very high since this company came public. The third quarter was no exception. We saw revenue growth of 181%. That landed the company at about $61 million in total revenue. Way ahead of Wall Street's estimate. If you double click on those results a little bit, you saw that the number of tests completed just about doubled, but revenue grew by 181% because it's actually they are charging more for each test. So, you have the number of tests doubling and revenue per test going up. That just creates magic on the top line. Trickling down a little bit more, we saw gross margin expand greatly from the sales leverage. Gross margin was up 1,400 basis points. It's now touching 70%. Operating expenses are growing quickly, but they only grew 67%. That's much slower than revenue growth. The net result was that the net loss came in at $13 million, or about $0.14 per share. That is far below the $0.37 loss that analysts were expecting. And that $13 million is almost a rounding error. This company has $825 million in cash. The strong results allowed the company to raise its guidance for the full year again. They now expect $202 million to $207 million in revenue. Previously, they were guiding for $180 million to $190 million. That's a nice boost. And that does represent 126% revenue growth for the full year. The report was just excellent.

Jones: It's amazing to me to see numbers like that posted by a company whose bread and butter is really centered around this Guardant360 test. One of the more surprising things, Brian, is that this test isn't actually FDA approved, right? At least not yet. 

Feroldi: That's correct. They actually are pending FDA approval. But insurers and pharmaceutical companies have been clamoring to get this thing because of the benefits that we talked about above, namely the extreme cost savings that come with it, as well as the convenience for patients. As you mentioned, it really enables clinicians to get a view of the DNA of a tumor. That can really help to guide their treatment process. This is a device that is just a win for the healthcare system all around, and it's no surprise that demand is just incredibly high.

Jones: And you can only expect demand to go even higher once they do secure that FDA approval. So far, Guardant 360 has been ordered more than 100,000 times by more than 6,000 oncologists. It's not just the physicians and the oncologists, it's also biopharmaceutical companies who are looking to expedite clinical development. Guardant is partnered with more than 50 biopharmaceutical companies that have actually ordered 360 and even their OMNI test as well. I think what's really remarkable, you mentioned, of course, you've got the insurers that are now coming on board. You've got biopharmaceutical companies, you've got physicians. They're expanding their capabilities, expanding their tests, really trying to drive some of the screening diagnostic tools and even the prevention much earlier in the timeline. They've got a LUNAR-2 test. What's really exciting to me about this is that you're trying to pinpoint and go after those that are asymptomatic, those that are at extremely high risk of getting cancer and be able to really drive early detection. So they've got a LUNAR test. It's a huge market. You're talking about $35 billion market opportunity for this company. Of that, $18 billion goes to that early prevention, early detection segment. That's really where they're going with LUNAR-2. There's a lot to like with this company, and when I see them posting triple-digit revenue growth, I get excited. But the growth runway I had is so long and so wide for a company like this.

Feroldi: Yeah, it really is. To your point, they're really focused on patients that are clearly symptomatic right now. The huge opportunity for liquid biopsies is really just used screening among the general population. As we've talked about on the show many times, the earlier you can detect and diagnose cancer, the chances of treating it successfully just go up massively. That is the real potential of Guardant and the other companies that are in the liquid biopsy space. Right now, Guardant is definitely the leader, and it's growing very nicely. But if liquid biopsies do what we hope that they can do, the growth runway for Guardant and all the other companies is just huge. I mean, we're talking about $100 billion in revenue potential if they can expand as they want to. The sky is the limit for this company.

Jones: Truly, sky's the limit. A lot to watch in this space. Of course, you've got Grail, the Silicon Valley start-up and spin-off from gene sequencing giant Illumina. You've also got Exact Sciences, who's also just secured a breakthrough device designation from the FDA for blood-based liver cancer detection. A lot to like in the space. Guardant Health, as you mentioned, the clear leader. 

Let's switch gears. Let's talk about some more notable earnings, this time turning our attention to the diabetes space. Specifically, we're going to be looking at Dexcom, and that is ticker symbol DXCM. The stock is up nearly 34% off of earnings. Brian, we've talked about Dexcom before, but when it comes to their specialty, which is CGM, continuous glucose monitoring, what exactly does that mean and why is it so important?

Feroldi: Dexcom has been the leader in the continuous glucose monitoring space for more than a decade around. When somebody has diabetes, they lose the ability to regulate their blood sugar levels. Historically, the way that people check their blood sugar levels is with a finger prick, and they put their blood up to a meter, and that gives them a point-in-time reading. The trouble is, your blood sugar is always changing. With people with diabetes, it can swing wildly based on a huge number of factors. So, those point-in-time readings make it hard for somebody to control their blood sugar because they just know where they are, but they don't know where they're heading or where they're coming from. CGM technology allows people to track their blood sugar levels in real time. Dexcom has been the leader in the space for more than a decade now. This company's growth has just been astronomical as more people with diabetes ditch their meter in favor of a continuous glucose monitor. 

Last quarter we saw a phenomenal quarter all around. Dexcom's revenue grew almost 50% to $396 million. That was way higher than Wall Street's estimate at about $345 million. The huge sales leverage allowed operating margin to expand. This company actually produced net income of about $60 million. Wall Street was looking for a number of about $15 million to $20 million. Way higher on the top line and the bottom line. The strength caused management to raise guidance. They're now expecting about $1.44 billion in revenue for the year. That represents top line growth of about 40%, also way higher than estimates. The stock took off after the company reported its earnings, and the numbers just make it clear why.

Jones: Yes. Phenomenal quarter for them. I think you've kind of seen, Brian, some, I want to say skepticism that the company can really keep up this type of revenue growth, 40%-plus over the long term. You do have competitors in the space. This is a crowded space, and they're all going after the same thing. Of course, the G6 has really been what everybody has been watching, but they've also got a G7 model coming online potentially in late 2020, early 2021. When you think about the competition, do you at all get concerned about them being able to sustain top line growth to this level?

Feroldi: Yeah, I think that was a major concern. A little more than a year ago, Abbott Laboratories launched a competing product that was going to be much cheaper than Dexcom's. It wasn't clinically superior. It did have some drawbacks when compared to Dexcom's system, but it was much lower price. That caused a lot of people to worry that Dexcom's margins were going to take a hit and that its demand was going to dry up. We've seen exactly the opposite. Dexcom's revenue growth has been extremely strong. It's actually accelerating. Dexcom likes to say that their technology is superior to the competition. They've been proving that for years. They've really helped to squash those fears. Shares are at an all-time high today, especially in response to this earnings report. You have to give management credit here for executing so well. I think at this point, you can safely say that the market for diabetes products is so huge that it's not a winner-take-all market. It can easily support multiple players. Dexcom has proven so far that it can maintain its leadership position even as the market gets more competitive.

Jones: Yeah, totally agree there. All right, let's keep it going in the diabetes space, this time looking at Insulet, that is ticker symbol PODD, and how they fared with their most recent earnings. Brian, last time we chatted when you were here at Fool HQ, we were talking about some of the top-performing med tech stocks of the year so far. We talked about Cutera, we talked about Nevro, but Insulet is right up there as well, up 123% on the year. Brian, this is a company you've got some former ties to as well, right?

Feroldi: Yeah. I was fortunate enough to join Insulet when it was still basically in the start-up phase in 2004. I spent about 10 years there before coming to the Fool. When I joined, the company was, again, still in the start-up phase. It's just so heartwarming for me to see that this company has now grown to the point where it's a $10 billion company. We saw that their stock price jumped very high. I think they're at an all-time high right now in response to their great third quarter results. 

Before we get into that, let's quickly talk about what they do. Insulet focuses on the insulin pump market for people with diabetes. Dexcom is on tracking your blood sugar side. Insulet is, if your blood sugar's out of range, what do you do about it? Insulet makes a tubeless insulin pump that is programmable by a remote control, and it constantly puts insulin into the patient's body to help them to keep their blood sugar in an acceptable range. When they eat, they can use their remote control to program their pump, which is just a small little device that's worn directly on the body, to give them a bolus of insulin to cover their meal. The insulin pump market is actually also very competitive. There's companies like Medtronic and Tandem Diabetes that have been in the space for a long time. But Insulet is unique in that it's the only insulin pump that is completely wireless. It's a very attractive option for people that have, say, small kids, or that have active lifestyles, or want to go swimming a lot. That's really Insulet's core market. They've been steadily taking market share since the device was launched about 10 years ago. Last quarter, we saw revenue growth of 27%. Revenue came in at $192 million. That beat the top line by about $12 million. It came in way ahead of their guidance estimate. Their growth was both in the U.S. and international, which is great to see. This company has finally become profitable, after about almost 20 years. We saw earnings of $0.09 per share vs. $0.03 estimates. And, we saw them raise their guidance. They now expect full-year guidance at about $722 million to $730 million. That's good for about 28% top line growth. A beat on the top line. Another fantastic earnings report from top to bottom.

Jones: Yeah, another beat and raise. Brian, this is more than just a company that's focused on the diabetes market, right? They're aiming to be really a device of choice for automated injectable drug delivery, even beyond the diabetes space with their Omnipod system. One example of that I think back on is with Amgen and their Neulasta treatment. Neulasta is a drug to stimulate white blood cell production for cancer patients who are taking chemotherapy. For them, of course, they're known for the diabetes space, but they've got some optionality, and really trying to carve out a name for themselves and really modernize how drugs get delivered.

Feroldi: Yeah, that is the promise of technology. The delivery demands of diabetes are higher than almost any other type of drug that you can deliver because of the variability and the time spans that need to be going on through the day. Delivering drugs for other diseases is actually a fairly straightforward and simple process by comparison. They have invested and worked with other companies to get their device to be used in other types of drug markets. Last quarter, we did see that revenue actually declined 20% from those other opportunities, but that's not all that concerning because revenue from that can wax and wane based on a number of factors. There is definitely embedded optionality in this company to grow that number significantly over time. But for the time being, that's going to take time before it ramps up. This company is still primarily focused on diabetes. The good news there is, they've come a long way, but they're still only about 5% penetrated into their core markets within the U.S. If you zoom out to include worldwide, it's about 1% of their target market. That is just the type 1 diabetes market. There's two main types of diabetes -- type 1, which is only about 5% to 10% of people with diabetes. The big opportunity for this company is to treat people with type 2 diabetes, which is a market size that's 10 times bigger. They are starting to penetrate that market, but that is an opportunity that will take decades to fulfill. That is the promise of Insulet, is that they've still only penetrated a tiny portion of their market.

Jones: Yes, yet another long-term growth opportunity. 

With that, we've covered three companies, Brian. Of the three, which one is your favorite, and maybe which one do you think won earnings so far this season?

Feroldi: Well, if I had to pick a winner for the earnings season, I would have to go with Dexcom. You're talking about 49% revenue growth, just blowing past estimates. They are just making it dead clear that the competition is not slowing them down at all, and the market opportunity is so large that it can easily support multiple players. It also just makes me happy to see that this company is now producing net income, whereas it was losing money for years. From a pure "who won third quarter earnings," I'm going to go with Dexcom. 

But, in terms of which company is my favorite, say, going forward, one thing I do like to do before I make those kind of calls is check on valuations. Guardant is trading for about 36 times trailing sales. Not yet profitable, but it is growing the fastest of these three. Dexcom is about 14 times sales, and 117 times next year's earnings. Insulet is about 15 times sales and 233 times next year's earnings. Those sky-high P/E ratios don't concern me because these companies are just now crossing over into the point where they're producing net income, so their margins are much lower than they would be ultimately. 

When picking between those three, I think I'm going to go with Guardant Health, even though their stock is priced the most aggressively at 36 times sales. Triple-digit revenue growth makes very expensive valuations become very cheap in not that long of a time. I just think the company's runway for long-term growth is enormous. How about you, Shannon?

Jones: So true. Guardant Health, far and away the better of the three. You mentioned the large market opportunity. They're really only just starting to scratch the surface. But, because we always agree, Brian, I'm actually going to do something a little bit different. Of course, I love Guardant Health, I think it's great. But I'm actually going to go with Insulet on this one. I don't think they had the best quarter. But like I said, I like the optionality, if they can learn how to execute well moving forward, especially when it comes to managing chronic diseases. Overall, long-term, now you're starting to talk about increased patient compliance, increased patient health outcomes. I think there's more to this company than meets the eye. Of course, as we're long-term investors, it takes more than one quarter to give a yay or nay for either a long option or even a short option for that matter. But for me, I like where Insulet is positioned, and I do like to see them, hopefully, position into a drug delivery platform. Again, I love that they're executing on diabetes, but I do think the long-term opportunity here is pretty impressive for Insulet.

Feroldi: I can't blame you there. I think all three of these companies deserve a spot on any medtech investor's radar, for sure.

Jones: Absolutely! That'll do it for this week's Industry Focus: Healthcare show! We want to thank you so much for tuning in!

As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is being mixed by Austin Morgan. For Brian Feroldi, I'm Shannon Jones. Thanks for listening and Fool on!