If you've had sticker shock while perusing the grocery store recently and decided not to buy something you normally would, DexCom (DXCM 0.35%) might not be the stock for you. The medical device company's status as a solid growth stock is much the same as it ever was, but it's not exactly the good deal that it might have been a few years ago.
Yet, there are a few reasons to believe that its high price tag could be justifiable for some investors. Let's break down this company's valuation and take a look at its growth prospects to see if buying a few shares could be a good financial decision for you.
There's no doubt that it's an expensive stock
If you're just learning about DexCom for the first time, it develops and sells continuous glucose monitors (CGMs), which people with type 2 diabetes use to control their blood sugar levels more effectively and comfortably than with traditional finger-stick tests that need to be done several times per day. It's also a company that's been great for investors with a total return of around 2,400% over the past 10 years. But after a run-up like that, it's no surprise to see a loss of momentum.
The trouble with DexCom's valuation is that it's currently at jaw-dropping levels. Take its price-to-earnings (P/E) ratio of around 196, for example. For reference, the average P/E multiple of a company in the medical devices industry is a grand total of a hair over 34. Could DexCom really be worth paying more than five and a half times per dollar of net income compared to an average stock in its industry? For most investors, the answer to that question depends on how much growth they expect to get from their purchase.
On that front, DexCom isn't half bad, but there are a couple of warning signs. Over the last two years (through the latest quarter), its net income fell by 8.3% to $211.7 million while revenue rose by 41.3%. Both of those are a far cry from the period between the start of 2018 and the start of 2020 when its sales jumped 105.4%. Competition could be to blame since powerful competitors like Abbott Laboratories are busy trying to steal market share, putting pressure on margins in the process.
Over the last three years, DexCom's selling, general, and administrative (SG&A) expenses shot up significantly as a share of its quarterly revenue as did its total quarterly expenses as a share of revenue. Given that the company doubled its U.S. sales force over the course of 2021 amid a major push with its direct-to-consumer sales operations, neither of the above is surprising, but it does indicate that the days of easy and relatively low-cost growth may be approaching an end.
And if margin pressure continues, it could drive the company into a few unprofitable quarters or worse, which would be an additional headwind on its stock price.
It could still keep growing and growing
Despite the recent slowdown in growth, it would be a big mistake to count DexCom out. For this year, management predicts that it'll make between $2.8 billion and a bit over $2.9 billion. Aside from the health and convenience benefits that patients love about its CGMs, they also tend to save money on glucose testing supplies to the tune of around $424 per month, according to management. Though competing products likely also offer significant savings compared to traditional glucose testing methods, competitors like Abbott Labs don't focus exclusively on making CGMs.
DexCom should be able to continue expanding into international markets and additional diabetes market segments more aggressively, even if chasing that growth is going to be slightly more expensive than in the past. In particular, its DexCom One monitor and software package is seeing significant traction in Lithuania, Latvia, Estonia, and Bulgaria, where more than 1% of the eligible patients in the market purchased the package within the first two months of it hitting the market. Rapid growth like that sure looks like a justification for the stock's high valuation.
But that doesn't mean it's a great pickup for everyone. Growth-hungry investors will find what they're looking for in DexCom, at least for the next few years. On the other hand, price-sensitive investors or traditional value investors should probably steer clear as it's a fact of life that the stock's rich valuation leaves it vulnerable to downward corrections during bear markets -- like the one we're in right now.
