Is DexCom the Next Big Growth Stock?

With shares of DexCom (DXCM 0.95%) falling 11% this year amid a steadily rising market, one might think that the medical device maker’s growth potential is ebbing compared to its former glory. But given its big ambitions to sell its medical devices globally, and with more and more countries giving it the green light to do business, rumors of its demise are probably premature.

Can DexCom become the next big growth stock thanks to its ever-increasing scale of operations, or has the market already priced in all of its future success? Let’s examine its plans and its valuation to try and reach a conclusion.

The case for a boom on the horizon

DexCom makes continuous glucose monitors (CGMs) for people with diabetes, so they don’t need to perform pinprick blood-sugar tests multiple times per day. The company’s devices, which patients wear all day, feed data to their smartphones so they know when to take their insulin. Compared to traditional methods for measuring blood glucose levels, wearing a device provides much more data, which in turn can lead to patients keeping their levels in the target range for more of the day, hopefully experiencing better health outcomes as a result.

Because of how big an improvement its monitors are, DexCom’s revenue and earnings are surging. Over the last five years, its trailing-12-month revenue climbed by 152%, reaching $3.4 billion, and its earnings per share (EPS) rose by 237%, arriving at $0.91. Wall Street analysts see its EPS more than doubling over the next two fiscal years. They may well see their estimates topped by the company’s actual performance, as with the third quarter’s results this year.

DexCom moving into new markets with its latest CGMs could keep the party going even longer. It just launched its G7 monitor in Canada in Q3, and it got regulators in France on board with covering the monitors for reimbursement by public insurance. It’s already selling in the U.K., Spain, Germany, Japan, Estonia, Belgium, and elsewhere. That makes for a total of 16 different international markets so far, with more on the way according to management. Regardless of the future, DexCom definitely earns the “growth stock” label based on its recent past.

The future might not be as bright as the past

Despite DexCom’s recent successes, investors should temper their expectations. There’s nothing wrong with the core business, and DexCom should keep adding to its top and bottom lines for the foreseeable future, and its shareholders should see decent returns. The main problem is that it doesn’t have any major catalysts in the works for stoking faster growth, and that could dampen future share-price performance — especially when paired with the other challenges, such as mounting competition and a high valuation.

Abbott Laboratories is making inroads in the CGM market with its line of FreeStyle Libre devices, and won’t be stopping. The presence of a competitor is unsurprising, and not necessarily negative. But Abbott Labs is a titan in the healthcare sector, and it can bring far more resources to bear on any given competitive fight. That’s a problem because there’s little that DexCom can do to differentiate its product ecosystem beyond what Abbott is already offering, and it has no competitive advantages to point out. So eventually DexCom might struggle to retain its market share against the bigger player.

As for DexCom’s valuation, its price-to-earnings (P/E) ratio is 103, which means its shares are incredibly expensive. For growth stocks, a higher-than-average valuation is to be expected as the market tends to bid up the shares of businesses it thinks will be successful in expanding over the near term. It’s true that DexCom still has plenty of room to grow into its international markets, driving more revenue and earnings over the next few years. But with competition fast approaching, and domestic markets soon to become saturated with relatively advanced CGM products that don’t need regular replacement, the pace of expansion is likely to decelerate soon enough.

The takeaway: DexCom isn’t the next big growth stock. Its heyday is probably in the rearview mirror, and now comes the long process of consolidating its market share against the competition. Of course, it could still be worth buying, if you’re looking for exposure to some growth without taking on an undue amount of risk.

Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Abbott Laboratories. The Motley Fool recommends DexCom. The Motley Fool has a disclosure policy.

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