A struggling economy, rising interest rates, and negative results from high-profile corporations continue to drag the stock market down. And although medical device specialist DexCom (DXCM -9.90%) hasn't entirely escaped the bloodbath, the company has been doing much better in the past few months.
Now, investors want to know whether DexCom can continue riding that wave for a while -- and there are good reasons why it might. However, there is also at least one major worry with this healthcare company. Are its shares a buy? Let's briefly look at both sides of the argument.
Reason to buy #1: Massive whitespace ahead
DexCom develops continuous glucose monitoring (CGM) devices that help diabetes patients with an essential function: tracking their blood sugar levels. Being too high or too low can lead to severe -- and sometimes life-threatening -- complications. CGM devices like DexCom's G6 compete with blood glucose meters (BGM) in helping people with diabetes with this critical task. And it seems clear which method has the advantage.
CGM devices take up to 288 readings per day -- one every five minutes. They also do not rely on painful fingersticks. By contrast, BGMs do rely on fingersticks and must be used manually to read a patient's glucose level at specific times. That's why CGM devices have been associated with better health outcomes for diabetes patients.
And yet, they continue to lag behind their BGM counterparts. The company's CEO, Kevin Sayer, recently said: "The domestic core market still has a long runway of growth ahead as we expect the vast majority of the population to adopt CGM to help them better manage their health." But notice that the U.S. leads most other countries in CGM adoption. That means if there is plenty of room for DexCom to grow domestically, there is even more room internationally.
And that's before we get into long-term trends in the number of diabetes patients increasing in the coming years. DexCom isn't the only player in this industry. Perhaps its most notable competitor is Abbott Laboratories, whose device, the FreeStyle Libre, has also been successful. But the market can accommodate multiple winners, especially as there seems to be enough room for them to grow.
Reason to buy #2: A new coverage plan
One barrier preventing many patients from enjoying CGM technology is third-party payers' unwillingness to cover it. Fortunately, a potential decision in the U.S. could expand those eligible for CGM coverage under Medicare. The existing coverage standards only include patients taking at least three insulin doses daily. But in October, the U.S. Center for Medicare and Medicaid Services (CMS) proposed a new plan.
Under the new guidelines, even patients not on intensive insulin therapy would be eligible for CMS coverage, provided they have a history of problematic hypoglycemia (when blood glucose levels drop below a specific threshold) or take at least one insulin dose daily. According to Wells Fargo analyst Larry Biegelsent, this change could double the U.S. CGM market opportunity to eight million patients.
That's not trivial, and as a leader in this field, DexCom would be one of the primary beneficiaries. True, the CMS still needs to finalize this decision, and until it does, anything could happen. But realistically speaking, these proposed plans generally look very much like the finalized ones. So there is an excellent chance the change in CGM Medicare coverage will become official. That's great news for DexCom.
Reason to sell: Rich valuation
Despite DexCom's seemingly bright prospects, one could argue that much of its future success is already baked into its stock price. The company's current forward price-to-earnings (P/E) ratio of 142 is substantially higher than the S&P 500's P/E of about 18.6 and the healthcare industry's average of 16.4. Failure to live up to its lofty expectations could send its stock price off a cliff.
Should investors purchase shares of DexCom despite this risk? In my view, it depends on each person's investment timeline. For those willing to stay the course for five years or more, DexCom is positioned to justify its high valuation metrics. In addition to an underpenetrated and rapidly growing industry, DexCom is developing newer devices to help diabetes patients achieve even better health outcomes.
The company has already begun the launch of its G7 in Europe and expects it to earn clearance in the U.S. by the end of the year. DexCom has a solid history of innovation, and we can expect the company to continue rolling out better devices down the road. That should help it increase its revenue and profits as it enrolls more diabetes patients, providing solid returns to investors in the process.
