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1 Green Flag for Eli Lilly Investors in 2022 -- and 1 Red Flag

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Does the upside outweigh the downside for this pharma giant?

Pharma giant Eli Lilly & Company (LLY -3.10%) has performed splendidly in the past year, leaving both the broader market and the pharmaceutical industry in the dust. But it's difficult to predict whether the company will continue on its upward trajectory for the rest of the year. Geopolitical tensions, which are already high, could escalate further and send Eli Lilly (along with the rest of the market) crashing.

If we put these marketwide worries aside, though, there is at least one key reason why the future looks bright for Eli Lilly. On the other hand, there is also a company-specific reason why investors might want to stay away from the stock for now.

LLY data by YCharts

Green flag: A highly promising pipeline

Developing and marketing novel therapies is capital-intensive, but companies that succeed in getting drugs approved can at least know that, thanks to patent protections, they'll have some time to recoup their investments and profit before competitors can come out with cheaper, generic versions. In the U.S., new medications are granted 20 years of patent protection. Once that period ends for a product, generics usually hit the market, driving sales down sharply for the original branded version.

For a pharmaceutical company to continue growing its revenue and earnings, it has to be capable of developing new products to replace the sales lost following the inevitable patent expirations. That's why having a solid pipeline is essential, and Eli Lilly possesses an admirable one, with a few dozen ongoing clinical programs.

Some of Eli Lilly's candidates are worth singling out for mention. First, there is Basal Insulin-Fc (BIF), a potential once-weekly insulin product for type 2 diabetes patients. People with type 2 diabetes don't always need insulin, but those who do typically take it daily. A weekly option could be highly appealing to these patients. BIF has already shown promise in a phase 2 clinical trial.

Image source: Getty Images.

Second, there is tirzepatide, a potential treatment for type 2 diabetes. According to Eli Lilly, tirzepatide significantly reduced average blood sugar levels and body weight -- both of which are critical for type 2 diabetics -- in a pair of phase 3 studies. Eli Lilly submitted tirzepatide to regulatory authorities in the U.S. and Europe in 2020. Investors can expect regulatory decisions in the coming months.

Last year, the research company Evaluate Pharma ranked tirzepatide as the most valuable research and development project in the pharma industry with a net present value of $22.1 billion.  Other promising products in Eli Lilly's pipeline include donanemab, an investigational Alzheimer's disease therapy, and mirikizumab, a potential treatment for ulcerative colitis.

Meanwhile, Eli Lilly's current lineup of drugs remains strong. Its revenue grew by 15% year over year in 2021 to $28.3 billion and, excluding its COVID-19 products, the top line grew by 10%. With several potential blockbuster products in the works, the company's future looks promising. 

Red flag: Valuation is a concern

The combination of Eli Lilly's exciting pipeline and solid financial results have contributed to an impressive stock market performance in recent years. But as a result of that run, the drugmaker's shares now look a bit overvalued compared to pharmaceutical industry peers such as AbbVie and Pfizer.

LLY PE Ratio (Forward) data by YCharts

Note as well that the average forward price-to-earnings (P/E) ratio for the industry is 11.7, while for the S&P 500 it stands at 18.2. Eli Lilly's shares, at a P/E of 33, don't look cheap at the moment compared to either of those averages -- not by a long shot. And that's something investors ought to keep in mind. 

Should you buy?

While investors cannot overlook Eli Lilly's pricey valuation, its exciting pipeline is arguably worth a premium, at least in my view. And there are likely more big winners to come. Eli Lilly has been a leader in the diabetes drug market for decades, a space it shares with two other leading players -- Novo Nordisk and Sanofi.

Investors can expect Eli Lilly to continue delivering new diabetes products in the coming years. The drugmaker also boasts candidates and approved drugs in immunology and oncology. Given its track record, and its lineup and pipeline, Eli Lilly looks like an excellent stock for long-term investors to buy, even at its current levels.

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