Many growth stocks experienced an incredible 2020 as it relates to stock price appreciation, but since then these stocks have been crushed. As a result, plenty of formerly fast-growing stocks regularly set new 52-week lows, despite clear evidence of strong business execution. For example, shares of Pinterest (PINS 0.04%) and Lemonade (LMND -1.55%) are trading down 67% and 81%, respectively, from their 52-week highs. And yet both companies have growing businesses.
With the price of both stocks down so much, they are now trading at incredibly cheap multiples. If these companies can continue growing their businesses as they have in the past and maintain their strong competitive advantages, then both stocks have the potential to skyrocket.
I think both companies have what it takes to succeed. If they continue to stay cheap, I will likely load up on shares in 2022. Here's why.
Stock in the self-proclaimed "visual discovery engine" has been whacked in 2021 and 2022, but that does not mean the business is performing poorly. Much of the drop can be attributed to a recent slowdown in the growth of monthly active users, but that alone should not have affected the stock so much. In the third quarter of 2021 (ending Sept. 30), Pinterest reported having 444 million monthly active users globally, up 1% year over year. That figure represents roughly 5% to 6% of the global population. When you start hitting levels this high, it becomes harder to maintain high year-over-year growth percentages. At this point, monthly active user growth becomes less important and average revenue per user (ARPU) becomes more significant.
In comparison to some other large social media companies, Pinterest's ARPU is low at $1.41, but it is still growing rapidly. In the U.S., ARPU was up 44% year over year in Q3, and internationally it grew 81%. It isn't unreasonable to think that Pinterest's global ARPU could reach $10, on relative level with Meta Platforms (META 2.20%) current rates. That leaves room for incredible growth. Pinterest management is focusing much more on increasing ARPU. One recent example is the use of Idea Pins, which allows customers to engage viewers more directly, resulting in more valuable advertisements.
Pinterest shares are trading at the most appealing valuation levels since going public in April 2019. The company's forward price-to-sales ratio is 5.4 and its forward P/E ratio is less than 20. This prices the stock cheaper than Meta, which trades at 21 times forward earnings at 6 times forward sales. Considering that Pinterest has the potential to grow its ARPU by multiples from today over the next five years, along with the fact it had impressive 8% net income margins and 31% free cash flow margins in the first nine months of 2021, I like the idea of loading up on shares right now.
In 2021, insurance specialist Lemonade consistently reported suboptimal loss ratios. Lemonade's artificial intelligence-based platform allows it to accept customer applications and process claims more efficiently, and according to management, more accurately than the competition. While its AI has helped the company generate tremendous growth and become one of the few insurance companies that customers actually enjoy using, it has also hurt itself in the short term. The company has scaled rapidly and added many new products to maintain its fast growth, but its AI takes time to learn and develop more accurate claims decisions. This has resulted in occasional outsized loss ratios (the percentage of premiums paid out in claims).
The company targets a loss ratio of 75% right now, but in Q3 2021 it reported a 77% ratio, driven by higher loss in younger product categories. However, Lemonade has also shown that the loss ratios for these products are improving. In Q3, the company reported that its loss ratio for its homeowner's insurance product improved 52 percentage points year over year, while its pet insurance loss ratio improved four percentage points sequentially. Management has said that as time goes on and its AI receives more data and learns from it, these ratios will continue improving.
Unfortunately, shares are priced as if the loss ratios will not improve at all. The company is valued at just eight times forward sales. If Lemonade can continue improving its loss ratio, profitability will rise as well. In the meantime, for the first nine months of 2021, the company reported $171 million in losses. The company has already seen major growth in the adoption of its products, growing its customer count 45% year over year to 1.4 million. If Lemonade continues to make it easy and hassle-free for consumers to apply for insurance and get paid out when they need it most, the company will likely continue seeing increased adoption. And with profitability improvements, the future of Lemonade could be much brighter than it is today, making right now a prime buying opportunity.
When a broad swath of the stock market falls together, I try to find companies in the bunch that are performing well and have bright futures going forward, yet are trading at rock-bottom multiples. This is the case for both Lemonade and Pinterest.
While they both have scratches on the surface, the underlying growth potential for each stock is incredibly appealing. With valuations at very appealing levels, I could see myself adding to my positions in both Lemonade and Pinterest in 2022.