Lemonade (LMND -2.56%) was an investor's darling when it came public. Many investors loved the company's innovative use of AI and its unique business model that is different from most insurance companies, and these differentiators sent the stock all the way up around $190 in January 2021. Since then, however, shares have tanked. They are now over 78% off that high and trade for less than $40.
Could Lemonade reach that former glory again this year? To reach $190, that would mean the company would have to skyrocket. While $190 in just one year seems unreasonable, I think that the company will bounce back in 2022, and it could reach $190 over the next several years. Here's why.
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Lemonade's innovation in insurance
Lemonade is bringing two disruptive things to the insurance industry. First, it is an artificial intelligence-based company, meaning that all of its decisions on insurance applicants and claims are based on AI and machine learning. This allows the company to make decisions on claims and applicants in minutes and allows consumers to have a pain-free process when submitting a claim.
Lemonade is also running with a completely different business model than traditional insurance companies. Instead of receiving the money left over after claims are paid out (the traditional model), Lemonade takes a flat cut from the premiums up front, and any money left over after claims are paid out goes to charity. This eliminates Lemonade's incentive to deny claims, making customers, the company, and charities all happier and better off.
The company has seen major adoption from users in the U.S., and this has resulted in incredible demand for more products. Lemonade primarily offers renters insurance, but in just the recent past, the company began offering, pet, life, and homeowners insurance. This rapid roll-out of products has resulted in young AI engines for each service -- engines that are still collecting data and learning more to become more accurate. As they are still learning, the engines have been less accurate than they would be if they were mature, resulting in subpar performance.
The company has seen major improvements in its gross loss ratio -- the percentage of premiums paid out in claims. For a mature service, Lemonade has a gross loss ratio goal of 75%, but this was higher in 2021. In the third quarter, Lemonade's total loss ratio was 77%, but the company saw strong improvements. The company's pet loss ratio improved four percentage points sequentially and its homeowner's loss ratio improved 52 percentage points year over year.
What makes Lemonade appealing today is not only its major improvements in existing products but its newest and potentially biggest product: car insurance. Instead of letting its AI collect data and learn organically as it has with other products, the company bought another car insurance company, Metromile. Metromile has data on over 400 million road trips and billions of miles driven, which will be fed into Lemonade's AI engine. This means Lemonade won't be starting from scratch with this big product, but rather it will be closer to maturity from the start -- meaning more accurate decisions from the very beginning.
The dark side of the moon
While the company is showing major improvements in its loss ratio, that does not guarantee its AI is perfect. No AI engine is perfect, and there have been plenty of instances in the business world where AI has been flawed and consistently produced inaccurate results. This could be the case for Lemonade if its loss ratio continues to be high or does not improve. The company has shown major improvements, but investors who are looking at Lemonade should keep this in the back of their minds.
Another reason Lemonade could continue performing poorly is its major net losses. In the first nine months of 2021, its net loss was $171 million -- more than the $87.5 million Lemonade brought in revenue during the period. If Lemonade continues to see the rapid adoption it saw in 2021 from customers as it continues to expand across the U.S., this net loss could decrease. On the flip side, if the net loss continues to stay high, that could keep the stock from bouncing back in 2022.
Is $190 reasonable?
For shares to reach $190 from a price of $34 as of this writing, that would mean shares would have to jump over 387% by the year's end. That performance would be jaw-dropping; it would also be incredibly unrealistic. For perspective, the SPDR S&P 500 ETF has only risen 264% over the past decade.
However, while this price target in one year should not be expected, investors could feasibly believe that the company could reach these highs again over the next several years. Lemonade's strategy to disrupt the insurance space is catching a lot of eyes from customers. Considering that Lemonade trades at a very low multiple of 2.3 times book value -- lower than established players like Progressive -- the company does not have tons of success valued into its stock. Therefore, if the company can successfully disrupt the industry, investors could be well compensated over the next five years.
