Lemonade (LMND 5.27%) and Square (SQ 3.38%) both disrupted legacy financial industries by targeting millennial users with their mobile apps.

Lemonade simplified the byzantine process of purchasing homeowners, renters, term life, and pet insurance with a single artificial intelligence-powered app. Square's Cash App bundled together peer-to-peer payments, Bitcoin (BTC 1.64%) purchases, free stock trades, and other financial services into a single platform.

At the time of its IPO in July 2020, about 70% of Lemonade's customers were under the age of 35. Chase Digital Banking also recently found that 31% of millennials -- the highest rate of any generation -- currently use peer-to-peer payment apps like Square's Cash App and PayPal's (PYPL 0.47%) Venmo.

Those high usage rates indicate Lemonade and Square could disrupt the legacy insurance and banking industries, respectively. But which fintech stock is the better overall investment in those secular trends?

Three friends use their smartphones together.

Image source: Getty Images.

The differences between Lemonade and Square

Lemonade's app, which can insure its users within 90 seconds and processes claims within three minutes, gets a lot of attention for its simplicity. It relies on chatbots to sign up users and AI algorithms to process claims.

But under that glossy surface, Lemonade still operates a traditional insurance business. It generates its revenue by writing premiums and attempts to keep its gross loss ratio under 100% to squeeze out some profits.

Shortly after its IPO, Lemonade launched proportional reinsurance agreements with other insurers. This model cedes 75% of its premiums to reinsurers, which pay Lemonade a 25% "ceding commission" for every dollar it cedes. This shift reduces Lemonade's reported revenue, but it passes on a lot of its risk onto other insurers that are tethered to its app.

Square, on the other hand, operates two main businesses: its Cash App, which generated 76% of its revenue in the first half of 2021; and its seller ecosystem, which produced 24% of its revenue. The Cash App's influence on Square's top line increased significantly last year as its users purchased more Bitcoin.

As a result, Cash App generated a whopping 85% of its revenue from Bitcoin sales during the first half, while its seller ecosystem generated 85% of its revenue from its payment processing segment, which primarily serves small to medium-sized businesses. Square also plans to integrate Afterpay (AFTP.Y), the buy now, pay later (BNPL) company it recently agreed to acquire, into both the Cash App and seller ecosystems.

Square's growing dependence on Bitcoin is a double-edged sword, since those trades generate much lower gross profits than its seller ecosystem. It also exposes it heavily to Bitcoin's volatile price swings.

Which company is growing faster?

Lemonade's revenue rose 40% to $94.4 million in 2020, but its reported revenue was distorted by the proportional reinsurance agreements that went into effect in the second half the year.

Lemonade's gross earned premium and in-force premium, which the company claims are more representative of its underlying growth, rose 110% and 87%, respectively, as its premium per customer increased 82%.

It ended 2020 with 1,000,802 customers, up 56% from the end of 2019. That figure climbed to 1,206,712 by the end of the second quarter of 2021.

For the full year, Lemonade expects its gross earned premium to rise 80%-81%, its in-force premium to increase 78%-80%, and for its total revenue to grow 30%-31% against the proportional reinsurance change last year. Analysts expect its revenue to increase 32% this year, then jump 63% next year as its year-over-year comparisons normalize.

However, Lemonade is still unprofitable and should remain so for the foreseeable future. The winter storm in Texas caused its gross loss ratio to briefly spike above 100% earlier this year, and its homeowners and renters insurance policies could face additional climate-related threats in the future.

Square's revenue soared 101% to $9.5 billion in 2020, as a massive surge in Bitcoin revenue from the Cash App offset the pandemic's impact on its seller ecosystem. Its net income fell 43% to $213 million for the full year after its higher-margin seller business stalled out, and it would actually have posted a net loss of $82 million without its investment-related gains.

Last month, Square revealed that its Cash App had over 70 million annual active transacting active customers, which comes close to eclipsing PayPal's latest count of over 76 million Venmo customers.

Analysts expect Square's revenue and adjusted earnings to increase 99% and 125%, respectively, this year. Its Bitcoin business is expected to continue growing as the cryptocurrency's prices hit record highs, while its seller business should recover as more businesses reopen.

But next year, analysts forecast its revenue and earnings to grow just 12% and 28%, respectively, against much tougher year-over-year comparisons.

The valuations and verdict

Lemonade trades at 19 times next year's sales, but it doesn't have any profits to value yet. Square trades at six times next year's sales and just over 100 times forward earnings.

I own both of these stocks, but I still consider Lemonade to be a much more speculative play than Square. Investors who don't own either stock yet should consider Square first as a core fintech play, then consider buying Lemonade if they're interested in the disruptive potential of its AI-powered insurance app.