Technology has come a long way, and has reached a point where it's now disrupting every corner of the economy. Lemonade (LMND +0.77%) embodies this movement.
The AI-enhanced upstart dealing in renters, homeowners, and pet health insurance made its public debut over the summer of 2020 with a slew of other tech-forward brands; and while it's a tiny player in the massive insurance industry, Lemonade is growing at a rapid pace.
Lemonade exemplifies an investor dilemma: Just how risky is a small company doing a fair share of status-quo disrupting?
Image source: Getty Images.
A primer on risk
Owning stocks (that is, owning a stake in a business) in and of itself generally isn't risky -- if you set your expectations going into a purchase. As to Lemonade specifically, it operates in an industry that isn't exactly in growth mode. Insurance has been around for centuries, and the fortunes of a typical company in this space hinge on its ability to attract customers (mostly away from competitors) and manage risk (keeping more insurance premium income than what it has to pay out in claims). Not exactly a sexy business operation.
But Lemonade (like some other tech-enhanced insurance company IPOs in 2020, like GoHealth (GOCO 1.18%) and Root Insurance (ROOT +3.73%)) has advantages compared to its much older and larger -- but slow-moving -- peers. It's tiny, having hauled in just $17.3 million in gross profit during the first nine months of 2020. It also had just over 941,000 customers at the end of September 2020. And it's using AI throughout its operations to grow its customer base and keep costs down. The insurance industry hauls in trillions of dollars globally every year, so suffice it to say there's plenty of room for Lemonade to make waves.
Sounds like a perfect business to own a slice of, right? But there is a risk here. If you think stock price volatility equals risk, this may not be the company for you. This is a momentum play. With a market cap of well over $4.5 billion as of this writing, investors are pricing in quite a bit of growth for this insurance upstart -- not to mention expecting the recent 99% year-over-year increase in in-force premiums to hold steam for the foreseeable future. Lemonade also operates at a loss (management expects adjusted earnings before interest, tax, depreciation, and amortization to be at least negative $100 million this year), though it is making progress toward reaching break-even. It had a massive war chest of $576 million in cash and equivalents and no debt at the end of September to cover expected losses, but managing its cash balance in the years ahead will be key.
So what's the risk here? I don't think the company will run out of money. Rather, it's that Lemonade's valuation is too high. If signs emerge that it is losing momentum in picking up new customers, Lemonade investors could lose value that could take many years to recover. Thus, as with all small disruptive companies, I advise that an initial purchase be kept very small so there's room to make further purchases over time. When I purchase a small stock like this, my initial buy is usually much less than 1% of my total portfolio value, and I'll make subsequent purchases on a quarterly basis (since I make regular monthly contributions to my investment accounts) if my original thesis for buying still holds. If you have the ability to take a similar approach, Lemonade might be a good fit.
There's a lot to like about Lemonade too
As I stated before, this company is using technology in an intriguing way to enhance its operations -- from the insurance sign-up process to the paying of claims. This holds special appeal among younger demographics, and Lemonade could be well on its way to creating a large base of lifelong customers. It also serves a very limited slice of the insurance market: renters, homeowners, and pet health insurance in the United States, and contents and liability insurance in Germany and the Netherlands.
That's where the future promise lies for Lemonade. It is still in the process of expanding its reach here in the states and around the globe (it's making a debut in France before the end of the year), and said it will be testing a term life insurance product as well. An expanding product portfolio in a growing number of countries could help this company keep its foot on the gas for a long time.
If you have the stomach for wild stock price changes and you've got the ability to purchase more over time, there is a lot going for Lemonade. There is an inherent risk in buying a piece of a young company early on, but the future potential payoff is also large. Just remember to mind the risks and keep any Lemonade stock purchase small for now.
