January was a big month for pharmaceutical stocks, with Merck (MRK 0.37%), Eli Lilly (LLY 1.19%), and Novo Nordisk (NVO 0.84%) all climbing 11%, according to data provided by S&P Global Market Intelligence. Investors are excited about the potential market for weight-loss drugs, and that attention has driven momentum for some of the larger pharma stocks.
There wasn't much major news from these companies in January, but there was enough positive buzz to build on the existing momentum ahead of quarterly-earnings reports.
The market is loving weight-loss drugs
Novo Nordisk led the charge with Ozempic and Wegovy. The company reported 42% growth in revenue from its diabetes and obesity-care products over the past year. That product segment represents more than 90% of the company's total revenue, so it's clear to see how that traction is translating to the stock's performance. Novo shares climbed 70% higher last year, outpacing most of its peers.
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Eli Lilly has also capitalized on that momentum by taking its own weight-loss products, Mounjaro and Zepbound, to market. The hype grew even more when Lilly announced its plan to sell directly to consumers with a new telehealth solution in January. The company launched a website called LillyDirect which should allow the company to more efficiently meet the surging demand for their weight-loss products. Assuming that Lilly can efficiently implement that new sales channel, it's a shrewd move to take market share before more competitors inevitably enter the fray.
Merck hasn't garnered the same interest on the weight-loss front, but the pharma giant is predictably working to change that. The company's management team attended multiple analyst events last month, and its commentary during those events clearly resonated with investors. Merck is exploring other potential health benefits of the weight-loss medications, such as improved liver function and cardiovascular benefits. If obesity drugs can be effective for additional indications, they're more likely to be covered by insurers, which is important for reliable revenue. This approach could be a fruitful one, given the head start that Merck's competitors have. Investors also reacted favorably to the company's plan to acquire Harpoon Therapeutics (NASDAQ: HARP), solidifying its participation in the drug-maker momentum in January.
Can this momentum continue in 2024?
Obesity is a major health issue that's not going away, and the demand for effective treatments is potentially enormous. Lilly and Novo both crushed analyst forecasts in their most recent quarterly reports, spearheaded by Wegovy, Ozempic, Zepboard and Mounjaro. It's fair to get excited about the opportunity that's unfolding right now, but investors still need to maintain rational expectations for future cash flows.
Merck, Novo, and Lilly are market leaders with robust pipelines of future products in development. Investors shouldn't become too focused on any single drug in their portfolio, especially if the competitive landscape is subject to change as more peers enter the space. It's hard to tell which products will dominate in five years, and it's similarly difficult to predict exactly how much insurance companies and government health plans will pay for weight-management treatments.
Merck's dividend yield is 2.3%, and its forward price-to-earnings (P/E) ratio is 15. That puts Merck firmly in value-stock territory, and it reflects the company's more tangential association with the weight-loss drug market. Novo Nordisk's forward P/E Ratio has ballooned to 36, and Lilly's is nearly 60. Both stocks have dividend yields below 1%. There still might be an opportunity to generate big returns if those companies wind up dominating the obesity-treatment market for years to come. However, it's clear that those businesses' valuations already assume strong operational performance. Lofty expectations necessarily come with volatility risk.
There's a bull case for all three of these pharmaceutical stocks that surged last month, but investors need to make sure that their risk tolerance and growth expectations are aligned.
