It was a volatile day for Eli Lilly and Co (NYSE:LLY) on Jan. 22. Shares sank right off the open, starting the day near $83.25. LLY stock ultimately hit a low of $82.40 before slingshotting higher and ending the day flat at $85.44.
So what gives?
Maybe it was just in flux as the industry was busy digesting Celgene Corporation (NASDAQ:CELG) buying Juno Therapeutics Inc (NASDAQ:JUNO) for $9 billion and Sanofi SA (ADR) (NYSE:SNY) acquiring Bioverativ Inc (NASDAQ:BIVV) for $11.6 billion.
Perhaps it was because the analysts at Credit Suisse downgraded LLY stock to underperform from neutral. They cut their price target to $82 from $88, arguing that the company is not on “track to hit its mid-term guidance of 5% annual sales growth” through the end of the decade.
That downgrade very well may be the cause of the fall, with investors ultimately deciding to shrug it off. It also comes on the heels of some other good news Monday. Eli Lilly received Food and Drug Administration approval for Elanco, its flea and tick treatment on dogs. Given the trend in pet spending, this should be seen as a positive development for Eli Lilly stock. Further, there was positive data found in a clinical 1b trial when combed Lilly’s Cyramza with Oraxol, a treatment from Athenex Inc (NASDAQ:ATNX).
So while there’s a lot to digest here, there are some positive developments for LLY stock. Further, the company’s fundamentals remain positive.
A Deeper Look at LLY Stock
Before Celgene purchased Juno, we explained why there were reasons to be bullish at current levels. Likewise, we also pointed out why Merck & Co., Inc. (NYSE:MRK) could soar another 10%. And while these stocks have potential, so too does LLY stock.
While Eli Lilly stock trades at a whopping 40 times trailing earnings, its forward price-to-earnings (P/E) ratio of 18 is more reasonable. Is it a screaming-low valuation? No. But for almost 7% sales growth and 20% earnings growth this year, it’s not bad. Plus, in 2018, analysts forecast another good year. Consensus expectations call for 2.5% sales growth and 11% earnings growth.
It’s not great growth, but it’s far from awful. Especially when you combine it with Lilly’s strong brand name and 2.5% dividend yield. Furthermore, the company’s operating cash flow and free-cash flow have been on the mend. After bottoming in 2016, both figures are rebounding higher in impressive fashion. Finally, small sales growth and double-digit earnings growth suggest margins will continue to head higher, another good sign for LLY.
Combined with a lower tax rate, the company’s prospects look bright.
Trading Eli Lilly Stock
When LLY stock fell on Monday, it looked like it was easily heading for the “no touch” pile. However, with an impressive bounce off the 200-day moving average, Lilly might be more attractive than we thought.
This moving average has been a key level of support throughout 2017 and buying Monday’s test would have been an opportune level to get long. The risk/reward was perfect because if LLY stock closed notably below the 200-day, investors could bail with minimal losses.
What do they do now?
Those who didn’t buy still have the same prospects, albeit with a worse risk/reward setup. That’s not the worst thing in the world, though. Look at the $85 level on the chart. This black line shows that this level has been significant for LLY stock. In its simplest form, longs could follow two rules: stay long Eli Lilly stock if it’s above $85 and above the 200-day moving average. If either is untrue, don’t be long.
That’s probably how I would approach the stock from this level. The valuation is reasonable and the dividend is attractive. However, there’s one hangup: Earnings. Investors may want to avoid taking a full position before its Jan. 31st fourth-quarter results. While good results could rocket LLY stock to $90 and new highs, poor results could drop it right below its two key support levels.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, he held a position in CELG.
