Lemonade (LMND -7.70%) stock has gone and done what I thought was impossible -- sliding below $30 per share and losing 80% of its value over the past year. Many investors are scrambling from this growth stock that hasn't been doing much growing but a lot of tanking.
I get the fear. But I also think it's unreasonable. I also wouldn't want to lose my principal when Lemonade has so much potential. Here's why I still have confidence in Lemonade stock.
The fear is real
Shares of the online insurer took off when it went public in the summer of 2020. But the enthusiasm quickly evaporated as losses piled up and the loss ratio crept higher. Both of these issues continue to plague the company. In the third quarter, the net loss widened from $31 million in the 2020 period to $66 million in 2021. The loss ratio, or roughly the difference between premiums collected and claims paid, increased five points year over year to 77%. Even more, investors were disappointed in Lemonade's acquisition of auto insurance company MetroMile, which brought more losses and higher loss ratios.
Lemonade's management was very excited about the announcement. It launched Lemonade Car auto insurance last year, and instead of waiting to enter various markets state by state, the MetroMile deal allowed it to enter these markets much more quickly. That should pad the top line and eventually trickle down to the bottom line. So although it adds higher losses now, the company's goal is that it will turn a profit that much more quickly.
So what are investors really worried about? Some early-stage companies expand too quickly, bleed cash, and eventually have to close down because revenue doesn't catch up. Peloton is experiencing something like this, as it scaled very quickly to meet demand while people were social distancing, and now it may be in a cash crunch. Activist investors called for a new chief executive officer, which the company acted on, and to explore a sale, which it hasn't, perhaps in the hope that it will right itself with new management and restructuring. This is the type of situation Lemonade investors want to avoid.
Why there's so much potential
On the other hand, so much of what's happening at Lemonade is positive. In-force premiums (IFP), which is the company's top-line measurement, consistently grows at about 90% year over year each quarter. That's due to a combination of two factors: new member sign-ups and increased premiums per policy. The latter has been growing impressively, increasing 26% in the third quarter. It means that overall, Lemonade customers are adding new types of insurance to their policies or taking out more expensive policies.
Both of these bode well for Lemonade, whose strategy is to target a young demographic and grow with them as their policy needs increase. Its ideal customers are in their early 30s, buying their first homes and their first cars. Last year, Lemonade added pet, term life, and auto insurance to its renters and homeowner's policies to make this a reality. Customer count is also improving, and Lemonade ended the third quarter with almost 1.4 million, or a 45% increase year over year.
In other words, the strategy is working, and so far, the company is increasing revenue at a rate that makes it look very competitive despite its heavy losses.
As an artificial intelligence-based company, it's also always honing its model for higher accuracy in pricing and rates. This should lead to an improved loss ratio and boost profitability.
I don't plan on selling
My investment in Lemonade stock is down quite a bit. But I didn't invest to see immediate gains. I find the business compelling, and I'm willing to wait and see it bear fruit. I am impressed with the company's management and strategy, and I feel confident in the company's long-term prognosis.
Lemonade reports fourth-quarter earnings this the week, and investors should look for improvements in the loss ratio and continued growth in IFP, revenue, and premium per customer.