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Is Now a Good Time to Buy Lemonade?

By Matthew Frankel, CFP® - Jan 22, 2021 at 6:12AM

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The insurance-company's stock recently pulled back -- should you take a closer look?

It's been an exciting ride for Lemonade (LMND 4.40%) investors. The company went public last summer at an initial public offering (IPO) price of just $29 per share. After bouncing around for a while, the stock has soared over the last few months. Even after pulling back by about 20% from its peak reached just over a week ago, Lemonade is still up by nearly 200% since the beginning of November.

Lemonade has an exciting market opportunity, but there's no doubt that it's an expensive stock. After the recent pullback, is now a smart time to add this disruptive insurance company to your portfolio?

Jar of lemonade on a white marble table, with lemons by its side.

Image source: Getty Images.

The bull case for Lemonade is strong

If you're not too familiar with Lemonade's business, the short description is that it's an insurance-technology company. It leverages artificial intelligence (AI) and other innovative technologies to create an insurance experience that's easier and more efficient than anything available. Not only can consumers get a quote and buy insurance coverage in minutes, but the claims process is quick and pain-free.

For the time being, Lemonade offers renters, homeowners, and pet insurance. But it has much greater ambitions. It's just started testing a life insurance product, and if it can replicate the stellar customer experience it's created for more than 1 million people, this could be a game changer.

Life insurance is an $800 billion market, and anyone who has purchased term life insurance knows that this is an industry that's just begging to be disrupted. Imagine being able to buy term life coverage at a reasonable price almost instantly, instead of dealing with insurance agents and medical exams.

Lemonade doesn't plan to stop there. Management has hinted that products like auto insurance could be on the horizon. Plus, the company is expanding internationally, having just launched in France in the fourth quarter of 2020, and already has a presence in Germany and the Netherlands. Most of its customers are new to the insurance world, and more than two-thirds are under 35, so Lemonade has an opportunity to build a lifelong customer base.

Furthermore, Lemonade takes a different approach to risk than most insurers, taking 75% of its collected premiums to buy reinsurance policies that essentially limit losses to a certain amount. If it doesn't use all 75%, the rest is donated to charity. The other 25% of premiums is used to cover Lemonade's administrative costs and to (hopefully) produce a profit.

Growth has been impressive so far. Lemonade reached 1 million customers after just over four years in business. It took State Farm and GEICO 22 and 28 years, respectively. In-force premiums nearly doubled year over year in the third quarter, and the company's loss ratio is getting smaller.

It's still a richly valued tech stock

Even though shares have pulled back recently, Lemonade is still a richly valued stock by any metric. The company isn't profitable and trades at a sky-high valuation of 91 times trailing-12-month sales. It's fair to say that there's quite a bit of future growth potential already priced into the stock.

Lemonade made a smart move recently and raised about $530 million to take advantage of the high valuation and fuel its ambitious growth. And while this gives the company some serious ammunition, there's going to be a ton of execution risk involved with building out a large-scale life insurance operation.

Is now a good time to buy Lemonade?

Unfortunately, there's no simple answer to this question. If you do buy, it's important to be prepared for quite a roller-coaster ride as the company's growth story continues to play out.

If you're planning to hold the stock for several years at a minimum and aren't worried about what the stock does in the short term, it's a good time to buy Lemonade. After all, this is a massive addressable market, and the company's stock price could multiply several times over if it's capable of large-scale disruption. For the time being, however, that remains an if, and the stock will behave accordingly.

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