So far, it hasn't been smooth sailing for the stock market in 2022. Since the start of the year, the S&P 500 index is down 14%.
While the broader market is down, stocks with high valuations have taken an even bigger hit for a more extended period. For example, the ARK Innovation ETF, Cathie Wood's flagship fund that invests in innovative companies, is down 57% over the last year.
One company feeling the pain is Goosehead Insurance (GSHD 1.96%), which is down about 70% since early October. The insurance agency is quickly expanding its business and increasing revenues. However, its profitability has been uneven, and investors are punishing its rich valuation.
Image source: Getty Images.
Its business is rapidly expanding -- at a cost
Goosehead is an insurance agency that sells insurance through its corporate headquarters and its franchisees. Goosehead's growth strategy includes aggressively onboarding more franchisees and investing heavily in technology. Ultimately, the company looks to be the biggest agency selling personal coverage, mainly homeowners insurance and auto insurance.
This aggressive strategy has led to stellar growth, with premiums increasing at a 40% compounded annual rate over the past decade. It has also grown premiums in its franchise channel by 52% since 2019.
Data source: Goosehead Insurance.
The downside to this focus on growth has been rising expenses and lackluster earnings growth. Last year, Goosehead brought in $8.3 million in net income, down from $18.8 million in 2020 and $10.3 million in 2019.
The first quarter saw good growth but larger losses
Goosehead's top-line growth was stellar during the first quarter. Revenue rose 32% to $41 million, while total policies in force, or the total count of policies placed by Goosehead with insurance carriers, grew 39%.
However, profitability wavered during the quarter. Goosehead's operating expenses during the first quarter were $40 million, up 38% from last year, excluding stock-based compensation. As a result, Goosehead posted a net loss of $5.4 million in the quarter, worse than its $1 million net loss in the same quarter last year. Goosehead's stock has been beaten with the rest of the market.
The stock still has a high valuation
Since October 2021, the insurance agency has seen its stock price drop from $181 to $56. During this period, investors have beaten up expensive stocks, and Goosehead is no different -- it has traded at a high valuation since going public in 2018. For much of the past year, the stock has traded at a price-to-earnings ratio (P/E) over 300 while trading at a forward P/E ratio over 200.
However, one positive aspect of the stock is that it now trades at a lower forward P/E ratio than it has for the past year. While this is still high, at 71.5, it's a sign that the stock is becoming cheaper by the day. However, it would still have to grow into its expensive valuation at current prices.
Here's how it plans to accomplish this.
Goosehead's long-term growth plan
Goosehead can be a stellar stock for investors with a long time horizon because of its franchise model. Renewal royalty fees -- or fees earned from the company's franchisees -- are management's preferred long-term revenue because of their high margins and predictable nature.
These fees can be especially lucrative because of the step-up in revenue when a franchise renews. During the initial agreement, Goosehead earns royalties of 20% from its franchises. However, these royalties jump to 50% when franchise agreements are renewed. Goosehead currently has nearly 1,300 operating franchises, up 41% from last year's first quarter.
Data source: Goosehead Insurance.
It is also investing heavily in its insurance platform, which looks to simplify the insurance-buying process, comparing quotes across its many carriers and getting customers the best deal possible. Goosehead also hopes to open up this platform to mortgage originators, builders, and fintechs to allow them to offer insurance quotes, as well as connect buyers with insurance agents quickly.
The market has been tough on all stocks, especially those with a growth focus that sacrifice earnings today in hopes of higher profits later. Goosehead is a company lumped into this group. However, with its long-term growth strategy still on track, it can be a stellar stock to buy today and gradually build up over time.
