If you were to strictly look at earnings multiples, you could easily miss a top growth stock like DexCom (DXCM 0.63%). Initially, value investors might scoff at the whopping 200+ times earnings that it trades at right now. But that wouldn't tell you the whole story.
The reality is that DexCom makes some highly coveted continuous glucose monitoring (CGM) devices that can be game-changers for people with diabetes, allowing them to easily stay on top of their glucose levels. And that can lead to some significant growth down the road. Should investors worry about the stock's seemingly high valuation or look past it?
DexCom has been rapidly growing its sales in recent years
In 2021, Dexcom's top line came in at over $2.4 billion, representing year-over-year growth of 27%. And compared to two years ago, when sales were just under $1.5 billion, the company's top line has expanded by 66%.
What's promising about the healthcare business beyond just its growth rate is that it generates great margins. At roughly $1.7 billion, the company's gross margin was nearly 70% of revenue in 2021. At that high of a rate, that means close to $0.70 of every dollar of revenue could cover the company's operating expenses. For a growth-oriented company like DexCom, that can translate into long-term profit growth as its products reach more people.
The P/E multiple may not always be helpful
DexCom's profit this past year was less than half of what it was in 2020, and that has weighed down its price-to-earnings (P/E) multiple. One reason for the decline is the business incurring a non-cash collaborative research and development fee of $87.1 million that wasn't there in previous years. The company also spent more on research and development. And as opposed to an income tax benefit of $268.6 million that propped up its earnings a year earlier, in 2021, the company incurred tax expenses of $19.2 million.
When looking at adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), which factors out non-recurring and unusual items, the company's bottom line in 2021 actually rose by 14% to $578.9 million, or 24% of revenue. This year, the company anticipates up to 20% revenue growth and a slightly higher adjusted EBITDA margin of 25%. However, even with a modest earnings boost, that likely wouldn't have been enough to make DexCom look cheap by any stretch. The reality is that for fast-growing companies like DexCom, a P/E multiple may not always be a useful way for investors to evaluate its share price.
To assess a company's value, especially over the very long term, investors need to consider the opportunities ahead for the business, not just a P/E ratio that a good or bad earnings result can quickly skew.
There's plenty of growth on the horizon
According to estimates from Vantage Market Research, the global market for CGM devices is growing at a compound annual growth rate of 10.8% and will be worth more than $13.2 billion by 2028 -- more than twice the size it is today ($5.1 billion).
One of DexCom's key initiatives is to roll out its devices to more international markets, which could generate significant growth in the years ahead. In 2021, international revenue grew at a rate of 44% year over year, while U.S. revenue rose at a more modest 23%. Meanwhile, international sales account for just one-quarter of DexCom's business. By expanding around the world, DexCom can quickly strengthen its top line and overall financials.
DexCom is a solid buy for long-term investors
According to an estimate from the Centers for Disease Control and Prevention in 2010, the number of Americans with diabetes could triple by 2050. The need to manage the disease will only be more important in the future as the number of patients rises.
Whether it grows internationally or domestically, there will be no shortage of opportunities for DexCom to generate significant growth for just not years but potentially decades. That type of growth can be difficult to capture in just a snapshot like a P/E multiple that looks at where the business is right now.
And with strong gross margins, as DexCom's business grows, so will its profitability, which means its valuation will look more reasonable in the future. DexCom may look expensive today, but if you're in it for the long haul (e.g., more than just a couple of years), this could be one of the best investments to put in your portfolio.