Eli Lilly (LLY -2.23%) and Novo Nordisk (NVO -3.18%) have been the two best-performing large-cap pharma stocks over the past 10 years. The core reason is their strong competitive positions in type 2 diabetes and obesity care.
Lilly's leading metabolic disease therapy is tirzepatide, which is sold under the brand names Mounjaro for type 2 diabetes and Zepbound for obesity care. Bullish analysts expect this lead metabolic therapy, combined with Lilly's follow-on offerings in the space, to hit $65 billion in annual sales by 2031.
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Novo's main product in this segment is semaglutide, which is available as Wegovy for weight loss, Ozempic as a once-weekly injection for type 2 diabetes, and Rybelsus as a once-daily tablet for type 2 diabetes.
Although Novo holds a first-mover advantage for this class of drugs in both the weight loss and type 2 diabetes settings, the Danish drugmaker is expected to essentially split these markets with Lilly by 2031.
Which of these supercharged growth stocks is the better investment option right now? Let's examine them more closely to find out.
A traditional and nontraditional valuation comparison
Even though Novo and Lilly both operate in the pharmaceutical industry, these two healthcare titans have dramatically different approaches to value creation. Novo focuses primarily on diabetes and obesity, while Lilly has a more diversified portfolio of drugs. How do they compare in terms of valuation and innovation?
One way to compare them is to use a three-factor model, which estimates the future earnings of a company based on its growth rate, costs, and shareholder rewards. Using this method, Novo's stock seems to be cheaper than Lilly's, as it trades at a lower range of multiples for its projected 2031 earnings (midpoint estimate of 16.5) compared to those for Lilly's stock (midpoint estimate of 28). However, this is a rough approximation that depends on several assumptions that may fail to pan out.
Another way to compare them is to look at their research and development (R&D) spending, which partially reflects their investment in innovation. Innovation is crucial for pharma companies, as their products have limited patent protection. What's more, R&D spending can be seen as a simple, yet useful, proxy for the net present value (NPV) of a company's pipeline, which is the sum of the projected cash flows from its clinical portfolio on a risk-adjusted basis.
Lilly has been investing heavily in R&D, spending about a quarter of its annual sales on developing new drugs over the past five years. Novo, on the other hand, has been more conservative, spending only about 13% of its sales on R&D over the same period.
This difference reflects the broader scope of Lilly's clinical efforts relative to Novo's over this period. Apart from diabetes and weight loss, Lilly has also been investing in multiple high-value areas such as cardiovascular care, immunology, neuroscience, and oncology. Novo, on the other hand, has been mainly focused on building on its dominance in type 2 diabetes treatment and gradually branching out into therapies for rare diseases.
Verdict
Lilly's higher premium is arguably well deserved. The company's substantially larger R&D spend as a fraction of total revenue, and resulting broader pipeline, make it less dependent on the future -- and largely unknown -- competitive dynamics of the type 2 diabetes and/or weight loss markets. So while Novo's more specialized approach to pipeline development should translate into a solid competitive position in these high-profile disease settings, Lilly's stock is arguably the better buy because of the company's broader and less risky approach to growth.
