Lemonade (LMND 1.26%) was the talk of the town when it went public a couple of years ago. The AI-powered insurance fintech got off to a blistering start in its efforts to grab market share, and its stock price exploded after it went public in July 2020, gaining 551% a few months later.

The company has added multiple insurance products to expand its reach and has made huge strides. However, there is one aspect of the company that needs significant work. But once management addresses this issue, Lemonade will shoot to the top of my list of stocks to buy.

An insurer that looks to give back to the community

Lemonade is on a mission to reimagine the insurance business. It leverages artificial intelligence (AI) to help people buy renters, homeowners, pet, and car insurance with just a few questions through its website or app. The company also leverages AI to address insurance claims quickly, and aims to appeal to younger customers.

Its mission is noble in that the company donates excess profits to charitable causes. Since its launch, Lemonade has given more than $6 million to charities picked by its customers -- $1.8 million this year alone. 

Expanding its offerings and its customer base

Lemonade has done a solid job of building the business and has achieved stellar growth by expanding its product offerings to customers.

Before 2021, two-thirds of Lemonade's policies were for renters insurance. Since then, it has launched homeowners insurance and pet insurance, and it acquired Metromile last year to accelerate its push into the $300 billion auto insurance market. Now, renters insurance accounts for less than half of its policies. 

Its gross earned premium has grown from $75 million in 2019 to $411 million through the first nine months this year. The total customer count in the third quarter was up 30% year over year to more than 1.7 million, and its in-force premium was up 76%.  

Lemonade's growth has come at a cost

Lemonade has done a stellar job of expanding its scale and taking a bigger bite out of the insurance market. However, this growth hasn't yet resulted in profitability for the insurer. In fact, its net losses have ballooned from $108 million in 2019 to more than $234 million through the first nine months of 2022.

Its losses have expanded due to its increased product offerings and higher claims costs as it develops its pricing models. Net loss ratio is a crucial metric for any insurance company: It measures the ratio of losses and loss adjustment expense, minus the amount paid to reinsurers, to its total gross earned premium.

A chart shows Lemonade's loss ratios from Q3 2019 through Q3 2022.

Image source: Lemonade.

Over the past three years, the insurance industry's net loss ratio has averaged 71% (lower is better). Lemonade management has stated that its goal is to keep its ratio below 75%. And in 2020, its net loss ratio was right in line with the industry average at 71%. That was when renters policies made up a majority of its business. However, after it expanded its offerings, its net loss ratio jumped to 93% in 2021 and 97% this year. 

What I want to see before buying

Lemonade's business is growing rapidly, but so are its losses. The stock price has fallen by nearly 90% since it peaked at $188 per share in early 2021, and now trades at a price-to-sales ratio of 5.9 -- near its lowest valuation as a public company.

LMND PS Ratio Chart

LMND PS Ratio data by YCharts

At this discounted price, the stock could be appealing to some investors. However, I will want to see improvements in the business before I buy. Lemonade must improve its risk models and price its policies more effectively so that it can turn a profit. I'd like to see its loss ratios improve over the next few quarters and get closer to management's goal of 75%. Until that happens, I'll be staying away from this stock.