Whether it's a new dieting fad or a modern spin on a common workout routine, people will try just about anything to live a healthier, fitter life. At the center of diabetes and obesity medications sit pharmaceutical giants Novo Nordisk (NVO -0.45%) and Eli Lilly. These two companies are the developers behind popular treatments Ozempic, Rybelsus, Wegovy, Saxenda, Jardiance, and Mounjaro. I'd put it at better-than-even odds that you've seen a commercial for at least one of these medications.

The demand for these appetite-curbing supplements is off the charts. And while both Novo Nordisk and Eli Lilly have witnessed generous financial returns from the popularity of these treatments, there is more to the story.

Both companies are battling supply challenges due to the unprecedented demand. Let's take a look at what that means and assess if these growth stocks deserve a position in your portfolio. 

Demand like never before

As I wrote about previously, demand for Ozempic and Wegovy in particular has helped fuel impressive growth for Novo Nordisk throughout 2023. During the first six months of the year, sales in Wegovy, just in the U.S., increased over 300% year over year. Moreover, Ozempic's popularity may be best underscored by highlighting the company's whopping 45% market share for GLP-1 products. While these stats are encouraging, investors should be aware of a couple of things.

In August, Novo Nordisk put an update on its website about Wegovy's supply capacity. Per the blog post, "Demand continues to outpace our increasing production of Wegovy. As a result, we anticipate ongoing supply disruption and are aware that some patients will continue having difficulty filling Wegovy prescriptions." While this shines some light on the demand for Wegovy, it's also somewhat vague.

Luckily, Novo Nordisk's CEO, Lars Fruergaard Jørgensen, recently sat down with CNN and brought more clarity around the supply disruptions. Per the segment, Jorgensen believes it could take years until demand for its diabetes and obesity medications is fully caught up. Although this might appear as a dent in the rocket ship, Novo Nordisk is far from the only company experiencing this same dynamic.

One of Novo Nordisk's biggest competitors is Eli Lilly, the developer of Jardiance and Mounjaro. During the company's second-quarter earnings call, the President of Lilly Diabetes, Mike Mason, shared the following:

In the short term, because we're seeing really unprecedented demand, we do still expect to see tight supply and some spot outages on Mounjaro through the end of the year. But I think, ultimately, as that manufacturing capacity ramps up, we will be out of the spot outages that we see. But in the next couple of months and quarters, I think we'll still see tight inventory.

The underlying themes here are obvious. Consumer demand for Eli Lilly's and Novo Nordisk's medications was higher than anticipated. This is likely due to a number of factors, including the sheer size of the diabetes and obesity markets, as well as the positive sentiment around the medications available.

The challenges, on the other hand, are a little more nuanced. In order for these medications to be effective over the long term, patients must continue to use them (for now). In other words, these are not one-time or periodic treatments. With so much demand from existing patients who rely on these treatments, as well as new patients looking for a prescription, what can Eli Lilly and Novo Nordisk do? 

A doctor writing a prescription for a patient.

Image source: Getty Images.

Building for the future

Leadership from both Novo Nordisk and Eli Lilly have made it clear that fulfilling demand is not going to be solved overnight. Whether it takes months or years, this is likely an intermediate-term challenge. But with that said, taking a look at each company's balance sheet may shed some light on the financial horsepower of the respective pharmaceutical operations.

As of June 30, Novo Nordisk boasted 36.4 billion Kroner (roughly $3.3 billion USD) of cash and equivalents on its balance sheet, while Eli Lilly held $2.8 billion. Both of these companies have made it clear that ramping up supply via heavy investments in manufacturing capabilities is a near-term initiative.

While ramping up expenses might look like a cause for concern, investors already have some evidence that this is exactly what these companies should be doing. For example, during Q2, Eli Lilly's cost of goods sold increased 26% year over year. The company attributed some of this growth to ratcheted-up manufacturing costs. However, despite the increased expense profile, Eli Lilly's gross margin still managed to expand by 300 basis points year over year.

Each company appears to have the capital needed to invest aggressively and combat supply constraints. My suspicion is that by doubling down on manufacturing and capacity needs, both Novo Nordisk and Eli Lilly may experience some muted margin expansion. However, I view this as largely a short-term dynamic, given the demand for the products.

Should you invest in Novo Nordisk or Eli Lilly?

When it comes to valuation, there are a number of different metrics that can be used. The tables below illustrate the price-to-sales (P/S) and forward price-to-earnings (P/E) ratios for Novo Nordisk, Eli Lilly, and a number of other competitors.

NVO PE Ratio (Forward) Chart

NVO P/E Ratio (Forward) data by YCharts.

The disparity of P/S ratios among this cohort is hard to miss. The capital markets clearly view Novo Nordisk and Eli Lilly as premium pharmaceutical investments over the competition, making each stock look overvalued. However, the forward P/E ratios may tell a different story. While both Eli Lilly and Novo Nordisk carry far higher forward P/E multiples compared to others, it could very well be that analysts are forecasting significant growth in profits for each company.

This is interesting because both Eli Lilly and Novo Nordisk have made it clear that expenses are likely to rise in the near term due to investments in manufacturing output. Yet despite rising expense profiles, Wall Street seems to believe that profits will expand anyway. To me, I think this is because both Novo Nordisk and Eli Lilly will offset expenses with exponential gains in sales. In other words, by increasing capacity, the companies will be able to better sell its treatments and reach a broader body of patients. Therefore, the investments these companies are making now are very much needed to sustain long-term top-line growth.

In essence, the augmented revenue should be far greater than the increased expenses, which would lead to more significant profits and earnings. While Eli Lilly and Novo Nordisk are not cheap stocks, it looks like the best is yet to come. Now could be a unique opportunity to initiate positions in the drugmakers.