What happened
Shares of Eli Lilly (LLY 1.19%) climbed 15.3% last month, according to S&P Global Market Intelligence. Promising drug trial developments and a strong outlook from management in its first-quarter report provided the upward momentum to the pharmaceutical stock.
So what
Eli Lilly caught Wall Street's attention early in April after announcing positive results from an early clinical trial for an experimental Alzheimer's drug. The pharmaceutical company has been attempting to develop Alzheimer's treatments for decades, and its latest candidate significantly reduced the accumulation of amyloid plaque that builds up in the brains of people with the disease. What is still unclear is whether the drug candidate, remternetug, provides significant clinical benefits to patients, and even if it eventually is approved by regulators, it's still a long way from being commercialized. However, the trial results were an exciting step forward from both a clinical and financial standpoint.
Later in the month, a major announcement on Lilly's diabetes drug tirzepatide thrilled investors. In a clinical trial, patients using tirzepatide achieved impressive weight loss results. A label expansion from the FDA allowing the drug to be prescribed specifically for weight loss could come in the near future, and that's a highly lucrative treatment market.
Image source: Getty Images.
The tirzepatide news coincided with the release of Lilly's quarterly earnings report. The drugmaker's Q1 revenue and earnings fell short of analysts' forecasts, misses that were attributed to falling sales of COVID-19 treatments and lower prices on diabetes medications that lost exclusivity. But investors overlooked those disappointing results and focused on the company's stellar outlook, sending the stock higher.
Lilly increased its 2023 revenue forecast by 3% to $31.5 billion, but left its earnings guidance unchanged as it anticipated increased marketing and product development expenses. Even with no change to expected short-term profits, investors still felt optimistic about the company's expectations for stronger demand.
Now what
Several factors have been hurting Lilly's revenue and earnings. Its COVID-19 antibody products previously generated significant cash flow, but demand for them has quickly dissipated. Loss of exclusivity on the blockbuster cancer drug Alimta has also been a major drag on the top line. The combined impact of these issues has been significant -- Lilly's revenue declined by 11% year over year in Q1, while earnings per share dropped nearly 30%.
Neither headwind came as a surprise to investors, yet the stock is up 17% year to date and up 44% over the past 12 months. Its forward price-to-earnings ratio is nearly 50. The stock also pays a dividend that yields less than 1% at the current share price, so it's not a meaningful contributor as an income investment. The current valuation premium is based almost entirely on the potential of Lily's product pipeline. Market-leading treatments for diabetes, obesity, and Alzheimer's could drastically improve patient lives and generate enormous profits. However, regulatory approval and competitive forces remain significant unknown factors.
There clearly are paths for Eli Lilly to deliver impressive long-term returns to investors, but it's important to understand the risks around this stock. Its price already reflects the assumption of significant successes in the future, so account for that before diving in.
