Is Lemonade Stock a Buy?

Lemonade (LMND -2.56%) stock tumbled on Aug. 5 after the online insurer posted its second-quarter earnings report. Revenue fell 6% year over year to $28.2 million, but it came in higher than analysts' estimates. The net loss widened from $21.0 million to $55.6 million, or $0.90 per share, which still matched Wall Street's expectations.

The company's growth rates might seem dismal for a stock that trades at nearly 40 times this year's projected sales, but those numbers only tell part of the story, since its year-over-year comparisons were skewed by a big change to its business last year. Let's evaluate that change, review the key metrics investors should focus on, and see if Lemonade stock is worth buying after its 11% post-earnings dip.

Image source: Getty Images.

Looking beyond Lemonade's revenue

Back in the third quarter of 2020, Lemonade launched proportional reinsurance agreements with several insurers. In its most recent 10-K filing, the company explained the set-up for this new model:

Under the Proportional Reinsurance Contracts, which span all of our products and geographies, we transfer, or "cede," 75% of our premiums to our reinsurers. In exchange, these reinsurers pay us a "ceding commission" of 25% for every dollar ceded, in addition to funding all of the corresponding claims, i.e. 75% of all our claims.

Sharing those premiums enables Lemonade to lower its capital requirements and boost its gross margin, but it also reduces reported revenue. That's why Lemonade's second-quarter revenue declined year over year, even as its number of customers, in force premium, premium per customer, and gross earned premium surged higher:

Data source: Lemonade. YOY = year over year.

For the full year, Lemonade expects its in force premium to grow 78% to 80%, gross earned premium to increase 80% to 81%, and total revenue to rise 30% to 32%. All three ranges are significantly higher than the projections management provided with the first-quarter report in May.

Lemonade served 1.21 million customers in the second quarter, while its ADR (annual dollar retention) rate of 82% improved from 81% in the first quarter and 73% in the second quarter of 2020. Lemonade's ADR represents the percentage of its in force premium retained over a 12-month period, which roughly translates to the number of customers it's retaining.

That rising percentage indicates Lemonade's expanding ecosystem -- which already include homeowners, renters, pet, and term life insurance products -- is getting stickier and locking in more customers.

Looking beyond its net loss

Lemonade's net losses look ugly, but its gross loss ratio actually declined sequentially from a whopping 121% in the first quarter -- which bore the full impact of the Texas winter storm in February. Its adjusted gross margin also expanded sequentially and year over year as it moved past the winter storm and reaped the cost-saving benefits of its new reinsurance agreements.

Data source: Lemonade. YOY = year over year.

Unfortunately, those improvements aren't helping Lemonade narrow its GAAP or adjusted EBITDA losses yet, and it will likely remain unprofitable for the foreseeable future.

Data source: Lemonade. YOY = year over year.

For the full year, Lemonade expects its adjusted EBITDA loss to widen to a range of $173 million to $169 million. That's comparable to its prior guidance, reflecting its prioritization of investments over earnings growth.

During the conference call, Lemonade CEO Daniel Schreiber said, "In the near term, we're not going to be optimizing for EBITDA." Instead, Schreiber said Lemonade would "keep monitoring every dollar that we invest" to see if it's "generating new customers on new products."

Lemonade remains a speculative (but fascinating) stock

Lemonade is trying to disrupt the traditional insurance market with an all-in-one AI-powered app that insures customers within 90 seconds. This approach, which bypasses the byzantine process of buying insurance plans, has made it a popular platform for younger and first-time insurance buyers.

But Lemonade also faces similar tech-forward competitors in the online insurance space, and the ongoing expansion of its ecosystem with new features (such as its upcoming auto insurance platform) could squeeze its margins and spread its resources too thin.

If Lemonade can gain millions of new customers over the next few years, it could certainly disrupt the insurance market in the same way Zillow changed how people list and buy properties. But it's still too early to tell if the company will achieve that goal, and it will remain a speculative stock until it gains more customers and expands beyond its core U.S. states.

That said, Lemonade's primary growth metrics are still rising, so investors who are willing to take a risk for potentially outsized gains should consider nibbling on this stock after its post-earnings pullback.