Lemonade (LMND 8.74%) was one of the hottest IPOs of 2020, and its run is spilling over into 2021. Shares are up some 150% since the stock's first day of trading last July, and this small insurance technology company's market cap has surged to about $10 billion.
Given that Lemonade's gross profit was only $17.3 million through the first nine months of 2020, the premium on this stock is, shall we say, quite high. Investors fall into two general camps at this juncture: Those who think the valuation is ludicrous, and those who see enough long-term potential to dismiss the current price tag as irrelevant for the time being. Here's why an investor might want to consider siding with the latter camp.
What's the deal with all this hype?
Let me first be crystal clear about one thing: This is not a call to rush to your broker with a huge buy order in hand. By all traditional metrics, Lemonade is not worth its $10 billion valuation -- at least not yet. Piling into a stock like this is just begging for trouble.
So why all the hype?
For one thing, this is a tiny company, but one that's riding incredible momentum. An insurance company that doubled its in-force premiums in spite of a wild year shaped by a global pandemic is noteworthy. Sure, it's far easier for a small company to double in size than it is for a large company, but it's nonetheless interesting to see a business based on something as unsexy as renters' and homeowners' insurance grow so fast. Lemonade closed out 2020 with 1 million customers -- a record-setting pace in the industry, as the company has yet to reach its fifth anniversary. Clearly Lemonade is on to something.
For another, optimism is incredibly high that Lemonade's early success can help it move into new markets (it's available in most U.S. states, Germany, the Netherlands, and France) and expand its product portfolio (pet insurance was just launched, likely the first of many new insurance lines). The company is using artificial intelligence to streamline everything from the new-customer onboarding process to payout of claims. And Lemonade is armed with lots of cash -- $597 million at the end of September 2020. It could add to its war chest, too: The company recently announced that it intends to use its sky-high stock price to sell 3 million new shares to raise additional cash. And the most valuable asset? Those 1 million-plus customers, many of them big fans who are happy to talk up their positive experience to others.
AI and an easy-to-use online experience, along with the company's philanthropic work -- it donates a percentage of its profits to a charity of the customer's choice -- all add up to a valuable brand that's disrupting a massive and less-than-beloved global insurance industry.
Intangible assets like branding and customer experience are tricky things to stick a fair valuation on, but they can nonetheless be powerful over time. Companies like Apple, Tesla, and Amazon are proof that a novel product or service with raving fans can lead to massive upside. Don't get me wrong, insurance is no smartphone, electric car, or sleek online retail shopping experience. But the seeds for an eventual long-term (think in terms of a decade or more) rise in insurance and fintech in general are there for Lemonade.
Why an investor might want to buy... and how
So what's an investor to do? Do not go out and bet the farm on this small-but-promising upstart. On the contrary, I'd keep any purchase very small. For me, that means buying an initial position in a company like Lemonade totaling 0.5% or less of my portfolio. If you have $100,000, that's a $500 initial stake. It might sound pointless, but if you are on to the next blockbuster business, you won't need a large position for it to earn serious returns. Then -- and this is equally important -- I forget about the daily, weekly, monthly, etc. price fluctuations in the stock, revisiting occasionally (like during quarterly earnings updates) only to make sure the original reasons for my purchase remain intact.
This accomplishes a few things.
First, one need not have an incredibly deep understanding of the insurance industry or spend time fretting over how large incumbent firms are trying to copycat Lemonade's early success. That's the management team's job, not an individual investor's. If you find yourself frequently checking the stock price, you might have too much riding on one single company.
Second, a tiny purchase might help even a "conservative" investor, especially one who invests in large, well-established companies -- say, Berkshire Hathaway. Many large firms -- like GEICO, which Berkshire owns -- are under fire from small upstarts and could eventually start to face some problems as a result down the road. Even a small purchase of a would-be disruptor might more than offset weakness in larger holdings later on. If Lemonade's promising run continues for the long-term, this could be the ticket to offset other insurance holding weakness. If Lemonade flops, a small bet, like 0.5% or less, won't do much damage.
And third, for investors looking for long-term growth, keeping an initial Lemonade purchase small allows you to buy more shares over time if its momentum has staying power. Or, if Lemonade shares are permanently humbled at some point, a small starter position mitigates the risk of a portfolio blow-up.
I'll stress again, any purchase in Lemonade should be kept small. This insurance technologist could be in the early innings of disrupting the global status quo, or it could fall flat on its face if it suddenly runs out of steam in the coming years. Such binary outcomes are frequently the norm when investing in up-and-coming brands, so take it slow. But if things work out, a small purchase of Lemonade could be enough to produce big investment returns.