Pet health insurance provider Trupanion (TRUP 5.67%) isn't a typical Warren Buffett stock, but that doesn't mean the Oracle of Omaha would completely shun it. Though you won't find human health insurance companies in the Berkshire Hathaway (BRK.A 0.93%) (BRK.B 1.09%) portfolio, Buffett is known for investing in businesses with wide economic moats, significant competitive advantages, and highly predictable recurring revenue.
How might the world's most legendary investor think about Trupanion, and how can other value investors apply his thinking to their own analysis? Let's see how this stock performs against Buffett's typical benchmarks, starting with the company's business model.
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What Buffett would probably like
Trupanion offers insurance to pet owners so that the right medical care will be more affordable if pets have a health problem. As an insurance provider, the company must balance the costs of fulfilling claims and acquiring new subscribers with regular subscription revenue. If successful, the company will feature consistent inflows and relatively low, unchanging costs. Effective insurance businesses have favorable unit economics, meaning they don't necessarily need to raise additional capital in order to grow.
Generally, Buffett would be attracted to Trupanion's stable base of revenue. In 2021, it made $699 million in total revenue across more than 1.1 million pets, with its top line increasing 39% year over year and its total enrolled pets growing by 36% in comparison to 2020. That caps off an uninterrupted five-year growth streak over which the company's annual revenue increased by 188%.
For Buffett, the "uninterrupted" part is quite important. With an average monthly retention rate above 98.7%, it's clear that customers are overwhelmingly loyal, which is another big point in this stock's favor.
Trupanion's relatively low variable cost burden would be another benefit in Buffett's eyes. Variable expenses associated with providing insurance only account for 9.8% of subscription revenue.
Finally, Buffett would be delighted by Trupanion's minimal debt load and cash holdings. With a mere $800,000 in debt and more than $213.4 million in cash against 2021's operating expenses of $139.3 million, the business is in good financial health.
What Buffett probably wouldn't like
Buffett's most significant hesitation about Trupanion would likely be the defensibility of its market share. Management claims that the company has moats in the form of its strong relationships with veterinarians and its automated veterinary invoice payment system, but it's unlikely that Buffett would find either of those points convincing. After all, simplified accounting systems and good relations might please vets, who are indeed key stakeholders for the business, but those factors won't help to attract or retain paying customers.
Then there's the issue with the unit economics of providing pet insurance, which aren't as attractive as they may first seem. Trupanion expects to make an average of $8.39 per month per pet after recurring expenses. That doesn't include the costs of customer acquisition, though. Out of $717 in expected lifetime cash flow per pet, each acquisition costs around $287.
So, if the company calculates that it'll make more from insuring each pet than the total costs of acquiring that pet and providing insurance, why has it struggled to reach profitability over the last five years? And why hasn't its free cash flow (FCF) shown any upward trend in the same period? Buffett would need to see both of these questions answered satisfactorily before investing -- and he'd probably want to see strong trends of consistent profitability and FCF growth, too.
What would Buffett do?
Given Trupanion's lack of actual economic moats, spotty profitability, and high customer acquisition costs, Buffett would likely pass on the company for now.
Still, I'm of the opinion that Trupanion could easily mature into the kind of business that Buffett would absolutely love to own. The company excels at acquiring and retaining customers. It's also clear that it's currently focused on growth rather than efficiently generating earnings, so the things Buffett might take fault with at the moment aren't necessarily enduring issues.
Once Trupanion demonstrates that it can reliably turn its strong subscriber and revenue growth into steady earnings growth, it'll go a long way toward meeting Buffett's criteria. Furthermore, when this pet insurer proves that its unique competitive advantages can't be easily replicated and that those advantages actually result in a more defensible market share, it will address other elements of Buffett's theoretical skepticism.
With these changes, Trupanion would have most all the makings of a classic Buffett stock pick. In a few years, this stock could very well deserve a spot in a Buffett-inspired portfolio.
