The past year has not been kind to growth stocks. For example, Cathie Wood's ARK Innovation ETF, a fund that looks to invest in the most disruptive and innovative companies, is down about 57% from all-time highs hit in February 2021.
The drop has been even steeper for young public companies that haven't turned a profit yet. Lemonade (LMND -1.39%) is one such growth stock and its price is down big. Since peaking in January 2021, the stock price for this innovative insurer is down 85.7% and can be bought for about $27 a share.
With the stock down so much, is now a good time to buy Lemonade?
This fintech is shaking up the way insurance is done
Lemonade is an insurer looking to upend the insurance industry. The company focuses on streamlining the insurance buying process. The way it does this is by leveraging big data and artificial intelligence.
For example, its chatbot, AI Maya, can help customers get policies by asking as few as 13 questions. However, from those 13 questions, it can generate 1,700 data points to analyze. The company generates so many data points by logging every aspect of a customer's interaction on its website.
Lemonade focuses on getting younger customers like millennials and those in Generation Z and turning them into customers for life. Last year it saw stellar growth in the business as it aggressively added customers.
Lemonade's rapid growth last year came at a cost
The company spent heavily on digital advertising while increasing its product offerings and geographic footprint. As a result, Lemonade increased its customer count to 1.4 million, up 43% from the year before. It also saw in-force premiums, or the dollar amount of active policies, at $380 million, up 78% from the previous year. This drove strong revenue growth of 36% during the year.
While the company achieved rapid growth, it also saw its net losses balloon during the year too. The aggressive advertising strategy caused sales and marketing expenses to jump 76% to $141 million. The company also saw losses on its policies increase, with loss and loss adjustment expenses total $17 million and $72 million, respectively. As a result, its net loss during the year was $241 million, following its $122 million net loss in 2020.
Losses rose as Lemonade added new product offerings
Last year, Lemonade's net loss ratio was 93% after posting a 71% loss ratio in 2020. The net loss ratio is a key metric used by insurers that measures losses and loss adjustment expenses minus the amount ceded to reinsurers divided by the net earned premium. The company's long-term goal is to keep this metric below 75%.
The losses can be traced to a couple of things. For one, Lemonade saw significant losses early in 2021 due to the winter storms in Texas and Oklahoma -- which caused nearly $7 million in losses. It also had an unfavorable prior period development for older losses that it was under-reserved for.
Management explained to investors that these bigger losses were partly due to the company's new product offerings, including homeowners and pet insurance policies. Before 2021, two-thirds of the company's policies were renters' policies. However, with the expansion into new insurance products, renters' policies now make up less than half of its book. As a result, the company will see bigger losses from new products as it learns to balance risks and price policies properly.
A stock with high growth potential but also high volatility
Lemonade is an intriguing stock that is rapidly adding to its customer base through new products. This year, management expects in-force premiums to be around $530 million and $540 million, while revenue is expected to grow 58% to 60%.
However, beating legacy insurers at their own game isn't going to be easy, and more growing pains can be expected. With Lemonade is expanding into car insurance, losses will continue to pile up until it builds up the data and knowledge to price policies effectively. Management expects adjusted EBITDA losses of $290 million to $275 million as a result.
While Lemonade offers investors high growth potential, it will continue to experience volatility until its loss ratios get closer to management's target, making it a stock best suited for growth investors with a high tolerance for risk.