If you're investing in a stock with a high valuation, you know that expectations are going to be high when it's time for the company to report earnings. Any miss compared to analyst estimates or underwhelming guidance can quickly lead to a sell-off, analyst downgrades, and a much different outlook for the stock as a whole.
Healthcare giant Eli Lilly (NYSE: LLY) has been trading at an inflated valuation for some time thanks to excitement around its diabetes and weight loss treatments, Mounjaro and Zepbound. Unfortunately, for shareholders of the company, it failed to meet expectations in its most recent earnings report on Oct. 30. And the numbers weren't even close.
Is the stock in trouble?
Eli Lilly's revenue grows by 20%, but falls short of estimates
Eli Lilly didn't have a bad quarter, but when perfection is priced into a stock, anything less than glorious results can end up weighing on its valuation. And while the company's revenue rose by 20% to $11.4 billion for the third quarter ending Sept. 30, that fell short of analyst expectations of $12.1 billion. On the bottom line, adjusted earnings per share (EPS) of $1.18 were also nowhere near the $1.47 EPS Wall Street was looking for.
The company's numbers would have been better, but a big problem for the drugmaker these days comes back to inventory levels. Demand is strong, but Eli Lilly says as it was fulfilling back orders to wholesalers for Mounjaro and Zepbound, they didn't end up ordering more supply and simply used their existing stock. That could create shortages again next quarter if wholesalers have insufficient supply on hand.
Another issue for investors is that Eli Lilly adjusted its guidance for the year, now projecting its adjusted EPS to fall within a range of $13.02 and $13.52 (the previous forecast was $16.10 to $16.60). This change reflects acquisition-related charges the company has incurred recently, but the decrease was disappointing for investors.
Should investors be worried?
Prior to earnings, Eli Lilly stock was trading at around $900. As of Monday, the stock was down to around $800, dropping more than 10% of its value in just a few days after the release of its earnings numbers.
Any kind of hiccup can weigh on the healthcare stock, which was previously trading at more than 100 times its trailing profits. It's still not even a terribly cheap buy when you look at its forward price-to-earnings multiple of 36, which is based on analyst expectations of next year's profits. When a stock is trading at such a high premium, expectations are elevated.
There's some bearishness around Eli Lilly of late, but there's reason to remain optimistic as well. Inventory and supply issues have been a problem for the company for a while, especially with Mounjaro and Zepbound being in such high demand. But over time, those issues should resolve, particularly as the company builds out more capacity; this isn't a problem long-term investors should be concerned about. The same goes for an adjustment to its earnings guidance, which was primarily due to acquisition-related charges -- these are short-term problems.
There isn't anything to suggest that Eli Lilly is suddenly on the wrong path or that demand for its products is starting to wane, which is why the latest news shouldn't change the outlook for investors.
Is Eli Lilly stock a buy?
If you're a long-term investor, I don't think there's much to worry about with Eli Lilly. The stock is still expensive, but given the long-term potential it has with Mounjaro and Zepbound potentially delivering billions in revenue for years to come, its earnings could catch up to its valuation over time.
I still see Eli Lilly as becoming the first healthcare stock to reach a $1 trillion valuation, so buying it on any kind of weakness can still generate good returns for investors who are willing to buy and hold.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
