As the world went on lockdown to attempt to slow the spread of COVID-19, an already fast-growing digital world got a shot in the arm and is now more important than ever. As a result, after a very brief meltdown in March, tech stocks have been off to the races and are largely responsible for the stock market reclaiming all-time highs this summer.
After such a meteoric rebound, pullbacks are to be expected, and many high-flying names have done just that in early September. Three that are worth a look right now are Lemonade (NYSE:LMND), Repay Holdings (NASDAQ:RPAY), and Cloudflare (NYSE:NET).
1. Lemonade: The insurance firm of the future?
Though my stock purchase strategy is far from infallible, Lemonade is exactly why I tend to steer clear of IPOs until at least a quarter or two of operating results are reported on. After pricing at $29 and raising over $300 million in fresh cash, shares of the tech-enhanced insurance outfit more than doubled after the first day of trading and more than tripled in the weeks following the debut of public trading in early July 2020. Since then, the stock has been humbled and now goes for "only" about $51 a share as of Sept. 11.
The pullback from highs and the company's first-ever quarterly report as a public company have me flirting with the idea of taking a small position. In a fragmented industry dominated by firms competing on price and touting customer savings with prolific TV ads, Lemonade is competing with technology. AI (read digital automation) permeates this business, from the customer-facing insurance quote interface to underwriting to the payout of claims. Lemonade is currently a small player in the industry that's yet to be available in all 50 states, and it offers only renters, homeowners, and pet insurance, but it's growing fast.
Second-quarter 2020 customer count increased 84% year over year to nearly 815,000, gross earned insurance premiums grew 121% to $35.3 million, and adjusted gross profit grew 204% to $7.0 million. Adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) losses were $18.2 million, narrowing by $4.8 million from a year ago. Lemonade will continue operating at a loss for some time, which will turn off many investors. But it's quickly getting more efficient as it adds customers and has plans for other types of insurance in the works. And at the end of June, the company had $184 million in cash, equivalents, and investments on the books (backing out the nearly $112 million in restricted cash held in insurance subsidiaries needed for things like claims) and no debt. That doesn't include the more than $300 million just raised via the IPO.
Given its still-small size, Lemonade's current market cap of $2.8 billion is a steep valuation that assumes rapid growth will continue for some time. But given how quickly it's disrupting the status quo in the small insurance lines it offers now, the long-term potential is there. If I buy, I'll start with a very small position totaling less than 1% of my total portfolio value.
2. Repay Holdings: The digital payments revolution is far from over
While paying with a card -- either in person or online -- has become the norm, real-time digital payments are still somewhat of a rarity in the debt service and business-to-business payments realm. According to digital payments software company Repay, far fewer than half of these industries make or accept payments with modern real-time electronic payment technology.
That's where Repay sees long-term growth potential. Via acquisition and a steady stream of new software integrations and partnerships, the company has been expanding fast as it helps banks, credit unions, and businesses update their payments and receivables operations for the new digital era. Total revenue increased 68% in Q2 2020 to $36.5 million, and adjusted EBITDA was up 55% to $16.2 million. Off about 10% from all-time highs reached at the beginning of September, shares currently trade for 13 times full-year 2020 expected revenue and 31 times expected adjusted EBITDA.
It's a premium price tag to be sure, but Repay plays in a very large sandbox (total annual payment volumes in debt service and business-to-business transactions are in the trillions of dollars) and offers a service that has suddenly become very important in this time of social distancing. And now that many organizations have been forced to invest in new digital payment capabilities, it's unlikely they'll simply revert to old habits once the dust starts to settle from the pandemic. Real-time digital payments -- not cash, check, and other legacy non-real-time forms of electronic payment like ACH -- are the future.
Also of note: After selling additional stock and cashing in stock warrants last quarter, Repay has ample liquidity on its balance sheet to keep growing. Cash and equivalents totaled $166 million at the end of June (compared to just $24.6 million at the start of the year), and debt was $260 million. However, with its services in high demand and profitability on the rise, I like Repay's long-term chances.
3. Cloudflare: Network infrastructure for the 21st century
Cloudflare is another high-flying small-ish software firm worth serious consideration for long-term investors. Even after falling more than 20% from peak prices following its second-quarter earnings report, this software-based internet infrastructure firm has still doubled in value year to date and currently trades for a hefty 25 times current year expected revenue.
But there's a good reason for the premium. Cloudflare provides web content delivery, security, and developer services and has taken a different approach to growth compared to its peers. It develops new services and offers them for free or at low prices to individual developers and small businesses, and then later starts marketing the services to larger potential customers. The strategy has worked well so far. Revenue is up 48% through the first half of 2020 to $191 million, building on its 49% advance in 2019.
As with other high-growth cloud software businesses, Cloudflare currently operates at a loss. Adjusted net losses have totaled $21.9 million so far this year. However, the profit potential is there, with the company's gross margins on services rendered exceeding 76%. And while the company narrows in on break-even, it is well funded to maintain its torrid pace. Cash, equivalents, and investments totaled $1.07 billion at the end of June, with only $366 million in debt. Granted, Cloudflare goes up against some deep-pocketed competitors like Amazon's AWS cloud platform, which has its own content delivery and web developer services. But Cloudflare's more modern wares have momentum on its side as many organizations large and small look for ways to update their operations in the wake of the economic lockdown.
Cloudflare is undeniably an expensive stock, pricing in a rosy outlook for the rest of the year and beyond. However, as it scoops up network infrastructure market share, this cloud stock is at least worth keeping an eye on. If I buy more, I'll take a similar approach as I will with Lemonade and Repay and keep my positions in each very small.