2 Brand-New Reasons to Buy Eli Lilly Stock Right Now, and 2 Reasons to Be Cautious

As a major pharmaceutical company that is constantly innovating and developing new treatments, Eli Lilly (NYSE: LLY) is always providing investors with additional reasons to consider buying its stock.

On the other hand, the nature of its industry means that there will often be solid new reasons to be a bit more cautious about making an investment in it. Here are two new reasons to be in favor of making a purchase, and two yellow flags to consider before doing so.

New data and new capital investments are going to pay off big

The story of Eli Lilly has, at least recently, been a triumphant one. Thanks to the popularity of its drug for type 2 diabetes, Mounjaro, and that medicine's sibling drug for weight loss, Zepbound, the company's trailing-12-month operating income has risen by 90.7% over the last three years to $15.1 billion. Demand for those products (both versions of the same compound, tirzepatide) has been so high that prior to October, they were in a state of shortage in the U.S.

That's why Lilly is making capital investments in manufacturing like they're going out of style. On Dec. 5, it announced a $3 billion expansion of a manufacturing site in Wisconsin that it acquired earlier this year, bringing its total commitment to the site to a cool $4 billion. Businesses that upsize their previous billion-dollar manufacturing investments by dropping multiple additional billions are businesses that are expecting to need a ton of manufacturing capacity.

There's simply no way that management green-lit the expansion if it didn't expect it to return more than its expense. And that's a new reason to buy the stock, as each additional investment in new facilities implies the company will be penetrating a larger total addressable market.

A big part of the rationale for expanding the supply capacity for making Zepbound and Mounjaro specifically is that Lilly is performing additional research and development work, with clinical studies to identify other conditions it could benefit.

It's also testing how its products compare to those of its primary competitor in the cardiometabolic medicine market, Novo Nordisk. Novo owns the blockbuster semaglutide, which is marketed as Ozempic for type 2 diabetes and Wegovy for weight loss.

On that note, on Dec. 4, Lilly published a preview of data from a phase 3b clinical trial that indicates that Zepbound is more effective at aiding in weight loss than Wegovy. Per the study, patients taking Zepbound lost 47% more weight than patients taking Wegovy after 72 weeks of once-weekly treatments. While the full results will need to be examined and approved for publication by a peer-reviewed scientific journal before they can be considered completely valid, investors can anticipate that the effectiveness of Zepbound will give it an edge in gaining and retaining market share. That adds to the argument in favor of buying Lilly stock.

The most intense part of the latest growth story is probably over

There are, however, two reasons to be cautious if you're thinking about buying this stock right now.

The most important is that there is simply no way Lilly can maintain its rapid growth forever. Indeed, there's already some evidence that the pace is on the verge of decelerating somewhat. Based on its third-quarter earnings report, drug wholesalers didn't buy as many doses of Mounjaro and Zepbound in Q3 as they had in prior quarters. On the day that report was released, the market bid down the stock.

Management has suggested that wholesalers had previously loaded up on doses of GLP-1 drugs like tirzepatide, leading to a (temporary) glut in their inventories. That might be true. But that explanation doesn't change the fact that the production capacities for these GLP-1 drugs have finally expanded enough that supply can meet existing levels of demand in the U.S., given the company's current level of marketing spending. Soon enough, further sales growth for Mounjaro and Zepbound will need to come from taking market share from a competitor, specifically Novo Nordisk. That will require Lilly to amp up its selling, general, and administrative (SG&A) expenditures, and there's no reason to expect those costs to fall afterward, as the competitive environment will only become more crowded over time.

Valuation could be too high

The second and less important reason to be cautious with this stock right now is that its valuation is on the higher side, and it has been for a while. Lilly's trailing price-to-earnings (P/E) ratio is 86, suggesting that investors are willing to pay higher prices for the stock relative to its earnings because they expect those earnings to continue to increase at a dramatically faster-than-average rate. It's possible that they will.

However, it's also possible that a couple of quarters during which results underperform investors' lofty expectations will prompt many to ditch their shares in search of greener pastures. That risk is in addition to the downsides one would normally expect from a few suboptimal quarters.

Overall, the balance of risk vs. reward favors buying Lilly today, and it probably will for a while. Just be aware that if you're looking for a stock that's trading at an affordable valuation and offers a chance for massive near-term growth, Lilly isn't that stock anymore.

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