How Much Is Eli Lilly Worth?

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It's hard to overlook Eli Lilly (NYSE: LLY  ) right now. From a numbers perspective, the stock practically jumps off the page. It's got a forward price-to-earnings ratio of 7.5, a dividend approaching 6%, and a return on equity of more than 40%. And all of this is from a well-known, trusted name in pharmaceuticals that's been around for well over a century.

At the same time, though, investors are all too aware of the gathering storm clouds. Over the next few years, the company's pipeline will get clobbered -- as the company's annual report noted, this year the company lost protection on Gemzar, next year Zyprexa takes the hit, and then in 2013 both Cymbalta and Humalog face the same fate.

But surely Lilly is still worth something, right? With that in mind, I decided to take a closer look to see whether pessimism might have knocked shares down to an attractive level.

It's a beautiful day in the neighborhood
One way to get an idea of what a stock might be worth is to check out how similar companies are valued. So let's take a look at how Lilly stacks up.


Total Enterprise Value/Trailing Revenue

Price/Forward Earnings

Total Enterprise Value/EBITDA

Price/Book Value

Eli Lilly 1.8 7.5 5.1 3.0
Abbott Labs (NYSE: ABT  ) 2.6 10.3 9.1 3.4
Amgen (Nasdaq: AMGN  ) 3.1 10.5 7.0 2.1
Bristol-Myers Squibb (NYSE: BMY  ) 2.2 11.7 6.4 2.7
Merck (NYSE: MRK  ) 2.7 9.6 8.1 1.9
Pfizer (NYSE: PFE  ) 2.3 7.5 5.8 1.5
Teva Pharmaceutical (Nasdaq: TEVA  ) 3.3 9.8 9.6 2.1
Average 2.7 9.9 7.7 2.3

Source: Capital IQ, a division of Standard & Poor's, and Yahoo! Finance. Average excludes Eli Lilly.

Using each of those averages to back into a stock price for Lilly, and then taking the average across those results, we can come up with an estimated price per share of roughly $45. This would suggest today's price of $34 and change is significantly undervalued.

A comparable company analysis like this can sometimes raise as many questions as it answers, though. For instance, is the entire group properly valued? A supposedly fairly valued -- or even overvalued -- stock among a bunch of other undervalued stocks may actually be an undervalued stock, and vice versa.

Also, while these businesses are comparable to Lilly, none is a perfect match. Teva, for instance, focuses on generic drugs and actually stands to benefit as other companies' drugs come off patent protection. Abbott has considerable exposure to patented drugs, but it has a much more diversified business that includes products in other areas such as diagnostics and nutritional products. And while Pfizer and Merck may be very similar in many ways to Lilly, the rate and impact of their patent expirations aren't exactly the same, and neither are the pipelines that they're counting on to help them rebound.

So with all that in mind, it's best to combine comparable company analysis with another valuation technique.

Collecting the cash flow
An alternate way to value a stock is to do what's known as a discounted cash flow. Basically, this method projects free cash flow over the next 10 years and discounts the tally from each of those years back to what it would be worth today (since a dollar tomorrow is worth less to us than a dollar today).

Because a DCF is based largely on estimates (aka guesses) and it attempts to predict the future, it can be a fickle beast and so its results are best used as guideposts rather than written-in-stone answers sent down from Mount Olympus.

For Lilly's DCF, I used the following assumptions:

2010 Unlevered Free Cash Flow $4.6 billion
FCF Growth 2010-2014 (6%)
FCF Growth 2014-2019 0%
Terminal Growth 0%
Market Equity as a Percentage of Total Capitalization 84%
Cost of Equity 12%
Cost of Debt 3.1%
Weighted Average Cost of Capital 10.5%

Source: Capital IQ, Yahoo! Finance, and author's estimates.

While most of this is pretty standard fare when it comes to DCFs, the academically inclined would probably balk at the way I set the cost of equity. In a "classic" DCF, the cost of equity is set based on an equation that uses beta -- a measure of how volatile a stock is versus the rest of the market -- and a few other numbers that I tend to thumb my nose at.

But when you get right down to it, the cost of equity is the rate of return that investors demand to invest in the equity of that company. So I generally set the cost of equity equal to the rate of return that I'd like to see from that stock.

Furthermore, putting together estimates for Eli Lilly hinges on figuring out just how quickly generic competition will eat away at off-patent drugs, how successful the company will be in getting drugs from its pipeline approved, and what kind of sales those new drugs will bring in. And, frankly, I just don't believe I'm in a position to come up with a particularly insightful view on these factors.

So what I've done instead is back into what the market seems to be assuming for Lilly. By starting with current analyst estimates for 6% annual declines over the next five years and then plugging in zeros for growth during the second half of the modeled period and for terminal growth, I arrived at today's price of $34.

In other words, the market seems to be anticipating that Eli Lilly will shrink around 6% per year for the next half-decade and then never grow again. Ever.

Do we have a winner?
The valuations that we've done here are pretty simple and, particularly when it comes to the DCF, investors would be well advised to play with the numbers some more.

That said, I think there's a pretty good case for buying Eli Lilly at today's price. Yes, the future is cloudy and there are significant risks ahead, but the market has priced Lilly's stock at a significant discount to much of the rest of the pharmaceutical industry. At the same time, the market's assumptions for Lilly's future seem pretty bleak, considering this is a company that more than quadrupled its sales between 1990 and 2009.

I've got my money where my mouth is on this one, as I'm a current Lilly shareholder. I don't have plans to overload my portfolio with Lilly shares, but I am planning on hanging on to the shares I own to collect the healthy dividend payouts and potentially score some nice capital gains if it's not quite the Mad Max future that Mr. Market seems to be prescribing.

Want to keep up to date on Eli Lilly? Add it to your watchlist.

Pfizer is a Motley Fool Inside Value pick. The Fool owns shares of Teva Pharmaceutical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Eli Lilly and Abbott Labs, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.

Read/Post Comments (5) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 26, 2010, at 1:50 PM, DannyHaszard wrote:

    Lilly has 30,000 of the best minds in the world working for them.

    Zyprexa damage Claims Still Unresolved-

    Eli Lilly's #1 cash cow Zyprexa drug sale $38 billion dollars annually has a greater risk of causing type 2 diabetes over the non-user of Zyprexa. So,here we have a conflict of interest that this same company also is a big profiteer of diabetes treatment.

    All the best for Eli Lilly and resolution of Zyprexa claims

    --Daniel Haszard Zyprexa victim activist

  • Report this Comment On November 28, 2010, at 1:28 PM, laKitKat wrote:

    <Eli Lilly's #1 cash cow Zyprexa drug sale $38 billion dollars annually>

    Not even close--Zyprexa sales are $4.9 billion

    < So,here we have a conflict of interest that this same company also is a big profiteer of diabetes treatment.>

    To suggest that they are pushing Zyprexa to create more type II diabetes to sell more drugs is irresponsible

    Regarding the article:

    The ratios are not helpful in making any decisions about value unless you do know what the expirations are going to cost and what's going to come on line in new products and for how much

    It's a huge amount of work but I am sure the Fool has many fine pharmaceutical analysts that could have put some estimates together

    As it stands, it is not a proper endorsement for or against the company and does not help us reach conclusions regarding investment potential.

    The dividends are good and in line with Merck and Pfizer. But how sure can we be there will be no large loss of capital as expirations start removing big pieces of revenue? They have to be able to replace nearly 57% of revenue between now and major expirations through 2014. Are they still worth $34 under these conditions? Is the 5.8% dividend even safe under these conditions and is it sufficient to pay us for loss of capital that may be coming? Have all these losses been priced in?

    How much is the pipeline capable of offsetting in 4 years?

    key questions and ones an article needs to answer to be useful

  • Report this Comment On November 28, 2010, at 8:27 PM, DTBoojum wrote:

    Great points, prof Stiglitz, not much point in analysing a stock investment if you're not prepared to actually count the cash. It's a lot more work than a guess here and a guess there, but what's the point otherwise?

  • Report this Comment On November 29, 2010, at 2:34 PM, gwgw10 wrote:

    Do they really need to replace 57% of revenue? I doubt it. You are assuming revenue from those drugs immediately goes to zero after the patent expires. It will surely go down, but not to zero.

  • Report this Comment On April 24, 2014, at 8:37 AM, mjy wrote:

    Will the lawsuit against Eli Lilly impact their stock long-term. Followed Takeda stock that took an initial 8.4 percent plunge.

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