Shares of Eli Lilly (LLY -2.65%) fell 20% in July, according to data from S&P Global Market Intelligence. The pharmaceutical stock plunged after one of the company’s competitors announced promising results from clinical trials of an obesity drug. Lilly has two obesity products currently driving sales and could lose market share prematurely if one of its competitors pulls off development smoothly.

Unpleasant news from a major competitor

On 17 July Roche (RHHBY 0.56%) announced positive clinical results for a once-daily pill for weight loss and type 2 diabetes. The Swiss pharmaceutical company’s candidate achieved clinically significant weight loss after one month of treatment in a Phase 1 study. The results of the Phase I study are still far from commercialization, but the announcement is undoubtedly a positive step. It is also Roche’s second pipeline candidate for this type of indication.

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The dosing method is notable for Eli Lilly. The company is one of the promising frontrunners in the weight loss drug space with its products Zepbound and Mounjaro. These two drugs are already blockbusters for the company, and it wants to expand its portfolio. It has several weight loss treatments and more convenient dosing methods in different stages of development.

First-mover status has undoubtedly benefited Lilly, but the good times may soon be coming to an end. Obesity is a major problem worldwide and is getting worse every year. Where most people and health experts see a global health crisis, pharmaceutical companies see a lucrative opportunity. Demand for effective obesity treatments will almost certainly remain strong for the foreseeable future.

Unfortunately, the strong demand for the suppliers of these drugs quickly attracts competition. Lilly and Novo Nordisk (NVO -8.37%) currently dominate most markets, but this will not last much longer. Roche’s recent announcement is one example, but the list includes a whole host of pharma giants and biotech startups. Pfizer (PFE -1.60%), Amgen (AMGN -5.00%)And Viking Therapeutics (VKTX -4.63%) All have promising products that could come to market in the next few years. These treatments will compete on quality and price, reducing the market share of the incumbent.

It’s a question of “when” rather than “if,” and Roche’s announcement was a serious reminder. Investors may need to temper their expectations about the cash flows generated by two of Lilly’s key products. Immediately after the report, Lilly and Novo Nordisk shares fell in unison, while Roche’s did the opposite.

LLY data from YCharts

Eli Lilly is still set for growth

Despite the decline, Lilly’s valuation still suggests bullish sentiment. Its P/E ratio is above 55, which can only be supported by significant growth from current levels. The stock is also not a compelling source of income. The 0.6% dividend yield is quite low compared to other established healthcare stocks. The 70% payout ratio suggests an opportunity to comfortably increase payouts from here, but again, the dividend yield only makes sense if the company’s earnings grow significantly.

LLY PE Ratio (Forward) data by YCharts

Lilly will need to deliver big results with its innovative new treatments to justify its valuation. That feat is entirely possible, but a rise in competition makes things uncertain. As long as the drugmaker has a positive valuation, the stock will be vulnerable to volatility if a direct competitor announces good news about its own weight loss treatments.