The best one can say about Lemonade (LMND -0.06%) stock right now is that is that it hasn't continued to slide into oblivion. It's down 55% this year, but it lost most of that at the beginning of the year. It's more or less hovering around a 10% loss in value over the past few months, so it looks like most investors think it deserves this price based on its recent performance.
Lemonade stock has been crushed under the weight of a market that's intolerant to unprofitable growth stocks, like many of its peers in this category. However, I think Lemonade has a very bright future, and I'm holding on to my shares. Here's why.
A product customers like
It's unusual for customers to like insurance companies, and that's exactly what the impetus was for Daniel Schreiber and Shai Winninger to start Lemonade. They sought to create an insurance company that was technologically advanced and customer focused, and this is the result. So far, they have achieved what they set out to do, and Lemonade has been demonstrating fantastic growth since it got started, mainly because consumers seem to like the ease of buying policies and filing claims.
There have been a lot of bumps along the way, though. Ultimately, buying Lemonade stock is a thumbs-up for confidence in its ability to stay on track and get through the scaling stage with profits. The thing is, it's definitely still scaling and figuring things out. Disrupting a traditional industry has the greatest potential for growth, but it comes along with starting from scratch instead of riding on the coattails of companies that have done this before.
If anything, the traditional, established insurance companies should be able to more easily update their legacy systems using the models and algorithms they have successfully developed for decades. Lemonade's founders are banking on their ability to build up their company with advanced, artificial intelligence-based technology that can't be matched by large companies bogged down in old systems. If so, Lemonade, with a more agile system, has the opportunity to outdo them. This has been the case for many past disruptors, such as Tesla. Most car companies are producing electric vehicles, but they're behind the lead disruptor.
These kinds of companies always come with a high-stakes risk-and-reward proposition, and the rewards can often take a long time in coming. That's where I see Lemonade right now.
What's taking so long?
Schreiber and Winninger both have strong entrepreneurial and tech backgrounds. They hired John Peters, who came from Liberty Mutual, as chief insurance officer, or the main underwriting manager. Lemonade is only seven years old; many of its competitors are literally a century old or more. So while Lemonade has the edge in technology, it's behind on underwriting standards, despite some key hires. Because it's in the insurance business, there's more to the equation than revenue minus costs equals profit. In fact, Lemonade considers its top-line metric to be in-force premium (IFP), not revenue. Underwriting means that it has to price policies to account for accidents and disasters, and it has to have enough premiums to cover payouts while still making a profit.
It has pushed hard to gain customers and increase IFP, and it's still developing its underwriting algorithms. Between launch costs and payouts, losses have widened. However, throughout this time, Lemonade's machines are learning. This is how it illustrated machine learning in an investor-day presentation.
Lemonade machine learning chart. Image source: Lemonade.
The loss ratio, as the graph below shows, has been going up and down over the past several quarters, indicating that the underwriting capabilities aren't quite there, yet.
Lemonade loss ratio chart. Image source: Lemonade.
But according to its machine-learning predictions, it should eventually look like this. (A lower loss ratio is better.)
Lemonade predicted loss ratio. Image source: Lemonade.
The potential is very compelling
Lemonade is achieving its high-growth goals. In the third quarter, IFP increased 76% over last year. That was a combination of premium per customer increasing 35% (to $343) and customer count increasing 30% (to 1.8 million). Management said it would now switch gears to focus on profitability, and that the third quarter would be the peak of losses.
There's plenty of risk involved here, and the machine learning could take a lot more time to effectively price policies to generate profits. But Lemonade is offering what looks like a better product and capturing market share.
Lemonade stock still couldn't be called cheap because it trades at nearly 6 times trailing-12-month sales. But it's a huge decline from the more than 100 times sales it previously reached. If losses begin to narrow in the fourth quarter, expect Lemonade stock to jump. If you have a long-term horizon, an appetite for risk, and confidence in Lemonade, you may want to take a small position.
