Here's Why Lemonade's High Valuation Could Actually Be Cheap

By most traditional metrics, such as price-to-sales, insurance disruptor Lemonade (LMND 1.44%) looks like an expensive stock. But in this Fool Live video clip, recorded on Sept. 23, Fool.com contributors Matt Frankel, CFP, and Trevor Jennewine explain why it could actually end up being a cheap stock for patient long-term investors. 

Trevor Jennewine: And another interesting aspect of the Lemonade business is that the premium per customer is rising. That was $246 in the most recent quarter, up 29%. The driver behind that is that the company is selling more higher-priced policies. It's shifting away from entry-level renter's policies and consumers are adding things like pet insurance that they're upgrading to homeowners insurance. The driver there is that Lemonade has really geared its business toward the younger generation.

It's investing heavily in sales and marketing and a lot of that is targeted at millennials, consumers that are under the age of 35. In fact, 70% of Lemonade's current customer base is under the age of 35 years old. During the most recent quarter, just to put that in context, renters policies accounted for 50% of new business. There's still a high percentage, but that's actually down from 75% of new business last year. The company is focused on engaging consumers at its early age and then growing with them as their insurance bids evolved. That seems to be working as well.

When you put all that together, customers are growing quickly, retention rates improving, the gross loss ratio is decreasing, and the premium per customer is rising. Lemonade's gross profit was at 81% in the most recent quarter, so strong growth. The company is not profitable on a GAAP basis and it's not free-cash-flow positive. Those are key metrics investors should keep their eye on.

The last thing I wanted to mention, and one of the reasons I'm excited about this company is that the insurance industry is a multi-trillion dollar industry. Lemonade puts its market opportunity in the U.S. at around $400 billion and $300 billion of that comes from its soon-to-launch auto insurance products. The company opened early registration earlier this year. They haven't set a release date yet, but it's on the horizon.

There are a few exciting things about this. First, it expands the market opportunity, like I mentioned. A lot of insurance companies will bundle homeowners and auto policies together and that streamlines things for the buyer. Lemonade hasn't been able to do that up until now. Once it adds auto insurance to its portfolio, it will be able to offer that bundle. For context, management believes that current customers spend about $1 billion each year on auto insurance. Pretty soon, we'll be able to get that through Lemonade. That's a tremendous opportunity just to cross-sell their existing customer base. Those are my thoughts on Lemonade. Do you guys have anything to add?

Matt Frankel: I do, but I was muted. You just told me that I am too old to be a new Lemonade customer apparently. I'm not in their core demographic. I age myself with these clunky headphones while both of you have AirPods, I need to get with it, but no, there are few industries I can think of that are in more need of disruption than insurance. Insurance is clunky at best. I don't know if either of you have ever bought life insurance, but that's about the worst sales experience I've ever been through. A nurse had to come to my house and take blood and weigh me, the application process took three weeks in all.

Lemonade does it in 30 seconds because of their AI powered technology. I'm a shareholder of Lemonade. I can't wait to see what they can do with auto insurance. Renters is cheap. I can tell you personally, my homeowners insurance is about 10 times what I used to pay for renters insurance. As their customers graduate, that's a big potential catalyst and as they add things like auto insurance, because auto insurance is about 10 times what renters is on average.