Warning: This Skyrocketing Stock Has a Hidden Risk

Eli Lilly (NYSE: LLY) is a major pharma company selling a broad range of drugs across treatment areas. However, one product, in particular, has driven growth in recent times and helped the stock roar higher.

I'm talking about the company's weight loss drug tirzepatide, which is sold under the name Mounjaro for type 2 diabetes and Zepbound for weight loss. Doctors have prescribed one of these drugs for patients aiming to shed pounds.

These drugs have quickly become blockbusters, driving double-digit gains in Lilly's revenue, and that's helped the stock take off, too. Lilly shares have climbed 200% since Mounjaro won regulatory approval in May of 2022. The U.S. Food and Drug Administration (FDA) gave the nod to Zepbound about a year ago.

All of this sounds fantastic and could make Lilly an excellent buy, but before you take action, consider this warning: This skyrocketing stock has a hidden risk.

Image source: Getty Images.

The popularity of weight loss drugs

Why have Lilly's drug and rival products sold by Novo Nordisk been so popular with doctors and patients? It's because these easy-to-administer drugs -- through a pen injector every week -- have delivered excellent results in clinical trials and the real world. They act on hormones involved in the control of blood sugar levels and appetite.

Demand for the treatments has been so high that they've been on the FDA's shortage list. Lilly's products were recently removed -- not due to a drop in demand but due to the $20 billion investment the company made in manufacturing capacity since 2020. Lilly is prepared to handle the demand for both Mounjaro and Zepbound.

What about the hidden risk? That has to do with drug pricing.

The U.S. government has been working to lower the costs of pharmaceuticals, in general, and has taken a particular interest in the pricing of weight loss drugs. Just last month, Novo Nordisk's chief executive officer testified before a Senate committee regarding the cost of its drugs. Sen. Bernie Sanders of Vermont, chair of the committee, said the drugs shouldn't be priced higher in the U.S. than they are in other countries.

A few months earlier, Sanders and President Joe Biden penned an opinion piece in USA Today, calling for Novo Nordisk and Lilly to lower the prices of their weight loss and diabetes drugs for Americans.

The cost of Zepbound

Currently, the list price for Zepbound is $1,059.87 -- and Lilly recently started selling the drug in single-dose vials directly to patients at the lower price of $399 to $549, depending on the dose. Today, Medicare doesn't cover weight loss drugs unless they're also are approved for another health benefit.

Novo Nordisk's weight loss drug Wegovy fits the bill since it's approved for reducing the risk of heart attacks and strokes. This is positive, but it also opens up the possibility of price negotiations with the government down the road.

The U.S., through the Inflation Reduction Act, already has taken a step toward the negotiation of some drug prices. As a result, pressure from the government to lower the prices of weight loss drugs could be a potential risk for both Lilly and Novo Nordisk.

On top of this, the possible commercialization of rival weight loss drugs also could put pressure on today's prices. If Lilly and Novo Nordisk want to stay ahead, they might have to lower pricing.

With the risk of pricing pressures from the government and competitors, Morningstar predicts low double-digit declines for obesity drug annual pricing from 2024 through 2031 as its "most likely outcome."

What does this mean for investors?

What does this mean for you as an investor? The risk of a declining Mounjaro and Zepbound price is real, and if these drugs' prices drop significantly, Lilly's revenue and share price may suffer, as well. But it's important to remember that Lilly also has newer weight loss candidates in the pipeline, and two are already in phase 3 studies.

If all goes well in late-stage development and these candidates enter the market, they could compensate for declining prices of older drugs. And Lilly also may gain from the sheer size of a full weight loss drug portfolio.

All of this means that it's important to be aware of the price-decline risk, but it wouldn't scare me away from Lilly stock today. The pharma company still is a leader in this high-growth market and could deliver strong growth well into the future, thanks to this position.

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Adria Cimino has no position in any of the stocks mentioned. The Motley Fool recommends Novo Nordisk. The Motley Fool has a disclosure policy.