Once the darling of growth investors, shares of digital insurance company Lemonade (LMND 1.14%) have plunged as it racks up losses in its quest to disrupt the insurance industry. With growth investing out of fashion in the current macroenvironment, the stock is down more than 60% over the past year. However, there are many signs of a robust business with a huge future ahead. Is now the time to buy Lemonade stock?
What makes Lemonade an exciting company?
Lemonade set out to shake up the insurance industry with its artificial intelligence-powered model and digital interface. It also donates money left over from consumer policies to a charity of the policy holder's choice. This trifecta alleviates many of the pain points of buying insurance. Buying insurance digitally means doing it on your own time and not feeling pressure from an agent. Using machine learning to power the model should lead to more accurate policy pricing, a win-win for both company and customer. And giving the leftover money to charity takes away the incentive to deny claims.
Customers are slowly being won over, and Lemonade has posted robust growth since it went public two years ago. Its top-line growth metric is in-force premium (IFP), which is the average total policy amount for the trailing 12 months. IFP increased 54% year over year in the second quarter to $458 million. Customer count rose 31% to nearly 1.6 million.
One of the foundations of Lemonade's growth model is cross-selling and upselling policies. That's why it has launched homeowners, life, pet, and auto insurance over the past two years, despite the associated costs and mounting losses. That is working according to plan, and 36% of all Q2 sales were cross-sells or upsells. It has also led to continued increases in premium per customer, which climbed 18% over last year in the second quarter to $290. It's also another notch on the path to profitability, since these wins come with no acquisition costs.
What are the risks right now?
Lemonade is accumulating customers and revenue. But top-line growth isn't the only sign of success. One of the key indicators of a viable business in the insurance industry is loss ratio. The loss ratio measures how much of a policy is paid out as claims, so lower is better. Established insurers with years of rigorous modeling typically have low loss ratios, but Lemonade is still working out its pricing as it launches new products in new locations. The loss ratio increased from 74% last year to 86% this year. Chief Executive Officer Dan Schreiber explained that loss ratios from newer customers and products are higher than lifetime loss ratios, and loss ratios from older cohorts are better than those from newer ones. That's something to keep in perspective, but it still has to play out to be believed.
Management expects the loss ratio to increase with the acquisition of online auto insurer Metromile, which was completed in July. Lemonade also foresees losses peaking in the third quarter before beginning to come down as sales begin to cover expenses. Net loss increased from $56 million last year to $68 million this year, but loss per share of $1.10 was better than analyst expectations of $1.33 in per-share.
How to weigh it up
Schreiber said that with the rising cost of capital, Lemonade would stop fundraising for now, and that it has enough money to grow until it becomes profitable. Many growth companies continue to raise and bleed cash for years, so this is an unexpected (but positive) update. Now the question becomes whether Lemonade can pull it off, and how long it will take to turn investments into profits.
Lemonade stock became very pricey, very quickly, so it's not surprising that it tanked when investors got nervous. However, so far, the business is progressing according to plan. It's going to take time before the company is profitable, but the path looks clearer at this stage. Lemonade is still not a stock for the risk averse, but long-term, it has huge potential, and patient, risk-tolerant investors should be rewarded down the line.
