1 Beaten-Down Tech Stock to Buy Right Now

Insurance is one of the largest industries in the world. Last year, property and casualty (P&C) premiums totaled $1.8 trillion, and that figure is expected to hit $4.3 trillion by 2040. At the same time, many of today's largest insurance companies were founded over a century ago, and their businesses weren't designed for modern data science.

That creates an opportunity for Lemonade (LMND 8.23%), a tech company that takes a unique approach to insurance. More to the point, the stock currently trades 58% below its 52-week high, due, in large part, to the catastrophic impacts of the Texas freeze earlier this year. But I think Wall Street is underestimating Lemonade's potential.

Here's why you should consider buying this beaten-down tech stock.

Image source: Getty Images.

Lemonade's advantage

Despite advances in technology, legacy insurance providers haven't changed much in recent decades. In most cases, actuaries still calculate risk, agents still sell policies, and adjusters still handle claims. But Lemonade re-imagines this business model with a digital-first, mobile-friendly platform.

Specifically, the company leans on big data and artificial intelligence to make its operations more efficient. For instance, rather than agents, Lemonade uses AI-powered chatbots to sell policies. This creates a fast, delightful user experience, while also reducing the company's payroll expense. In fact, Lemonade employs just one person per 1,700 customers, while rivals require one employee per 150 to 450 customers.

More importantly, it takes just two minutes to buy insurance, and claims are paid in as little as three seconds. But in that short window, Lemonade collects 100 times more data than legacy systems, giving the company a significant advantage. Lemonade uses that data to quantify risk and detect fraud, creating a network effect that should make its business cheaper and more precise over time.

For instance, as Lemonade correlates certain data points with increased risk, its AI models should be able to underwrite policies more accurately. That means its loss ratio (i.e. the percentage of premiums paid out in claims) should trend lower over time, allowing the company to keep more money. In turn, the combination of Lemonade's highly automated business and its increasingly predictive AI models should allow for lower prices.

Image source: Getty Images.

Lemonade's performance

As it turns out, that's exactly what's happening: During the most recent quarter, Lemonade posted a gross loss ratio of 74%, while the P&C sector as a whole has averaged 82% in recent years. And Lemonade's entry-level renters insurance is typically 50% cheaper than competing policies.

Not surprisingly, the company has added new customers quickly. In fact, Lemonade reached 1 million customers in less than five years, while it took many of its rivals two decades (or longer) to hit the same milestone. More importantly, 70% of the company's customers are under 35 years old, which means Lemonade is well-positioned to grow as its clients' needs change.

For instance, renters insurance represented 75% of new business one year ago, but that number has dropped to 50% as more people have purchased higher-premium products, such as homeowners and pet insurance. This has translated into a strong top-line performance, though Lemonade still operates at a loss.

Source: Lemonade SEC Filings. TTM: trailing 12 months. CAGR: compound annual growth rate.

As a caveat, Lemonade is free-cash-flow negative. Investors should watch this metric closely in the coming quarters, as it provides insight into the long-term viability of the business. If Lemonade is unable to generate positive free cash flow in the next year or so, it may be a red flag.

Lemonade's growth strategy

At the time of its initial public offering in July 2020, Lemonade offered renters and homeowners insurance, and the company sold coverage in just 27 states. Today, Lemonade insurance is available in all 50 states, and its portfolio now includes pet insurance and term life coverage.

More importantly, the company recently announced Lemonade Car, its soon-to-launch auto insurance product. This adds $300 billion to its market opportunity in the U.S. alone, bringing the total to over $400 billion.

Tying this all together, Lemonade's digital-first, mobile-friendly approach has made it a consumer favorite. And going forward, the company's AI-powered platform should drive efficiency in the form of workflow automation, better fraud detection, and more precise underwriting, all of which should translate into lower prices. This virtuous cycle should strengthen over time, helping Lemonade capitalize on its massive market opportunity.

That's why I think it's time to buy this beaten-down growth stock.