Clover Health Just Became a Meme Stock -- Could Lemonade Be the Next Short Squeeze?

Earlier this week, frenzied Reddit traders sparked another short squeeze, this time targeting Medicare Advantage plan provider Clover Health. Venture capitalist Chamath Palihapitiya recently took the company public through a special purpose acquisition company (SPAC). But since its debut, Clover has been a disappointing investment, as the stock has trended steadily downward.

That changed on Monday, when the Reddit community took up the cause. In less than 72 hours, Clover's share price soared 200% to a high of $28.85. This is Reddit's latest reminder that individual investors can indeed move the market.

But Clover isn't the only stock with high short interest. Investors have also shorted 29% of Lemonade's (LMND -2.38%) float. That makes this tech stock a prime candidate for the next short squeeze. Here's what you should know.

Image source: Getty Images.

Should you buy Lemonade?

Lemonade is a tech company looking to disrupt the insurance industry. It blends a digital-first business model with big data and artificial intelligence (AI). For example, Lemonade uses AI-powered chatbots to engage customers and price policies, not brokers and actuaries.

Theoretically, this should give it an advantage -- but Wall Street is skeptical. Lemonade faces competition from titans of the industry like StateFarm and Berkshire Hathaway's GEICO, both of which dwarf this tiny tech company in terms of earned premiums and profitability.

In addition, Lemonade trades at a pricey 62 times sales. From that perspective, it's easy to see why short-sellers have targeted this stock.

So what should you do? I'll start with this advice: Don't buy Lemonade looking to make a quick profit.

That type of short-term thinking rarely works, and it's just as likely that you'll lose money. If you're going to buy Lemonade, do it because you like the company's long-term prospects. After all, its unique business model is gaining traction with customers.

In fact, Lemonade surpassed 1 million customers in 2020, less than five years after it was founded. By comparison, it took StateFarm and GEICO 22 years and 28 years, respectively, to reach that milestone.

Moreover, Lemonade posted a better gross loss ratio (i.e. the percentage of premiums paid out in claims) than either of these rivals last year, an indication that its AI-powered business model may indeed be an advantage.

Source: Berkshire Hathaway, Lemonade, and StateFarm SEC Filings.

Even so, Lemonade has a lot to prove, and its stock has been prone to volatility in the past. That's why investors shouldn't buy with a short-term mindset.

But what if you already own the stock? Should you sell if Lemonade gets caught in a short squeeze?

Should you sell Lemonade?

This is a trickier situation for current shareholders. I happen to fall into that category and would normally advise against selling just because the share price pops. That being said, most rules have exceptions.

There is no correct answer. Whether you should sell or not depends on your comfort level with volatility. If you believe Lemonade can disrupt the $5 trillion insurance industry, then its market cap of $6 billion is a fraction of what it could be. Even if a short squeeze triples the share price, Lemonade would still be relatively small compared to its competitors.

But consider this scenario: Let's say the stock pops and you can't sleep at night because you're so worried about losing those gains. In that case, you should consider selling. No investment is worth more than your well-being.