After beginning to slide in 2021, Lemonade (LMND -0.33%) stock continued to tank, losing almost 70% of its value in 2022.
That sinking performance masks what were actually incredible achievements over the past two years. Its most recent development is the launch of auto insurance in the huge market of Texas. With Lemonade's stock at a new low and its business set up to shine, is it finally time to buy?
A booming business
Lemonade operates an artificial intelligence-powered digital insurance business with a twist. The twist is that it's a registered B corp, which means it has a social or environmental mission. It received that status because it offers policy holders the option to donate the remainder of unused annual policy funds to charity.
That's one element of a company that was designed from scratch to be customer-centric and provide a modern alternative to traditional insurance.
Lemonade is still a small company compared to the century-old behemoths that rule the industry. But it's growing quickly as it rolls out new products across new states and strives to speak the language of a younger generation.
Gross earned premium, or the amount of policy dollars, increased 71% over last year in the 2022 third quarter. Revenue increased 107% to $74 million, and customer count grew 30% to 1.8 million.
The company's model is to upsell and cross-sell policies as it recruits new customers at a young age and grows with them, leading to a 35% increase in premium per customer over 2021 in the third quarter.
What's wrong with Lemonade?
So what's been holding back the stock? There have been two problems with Lemonade as it grows, and they're big ones.
First is the mounting losses. Net loss rose from $66 million last year to $91 million in the 2022 third quarter. This was in large part due to both the acquisition of auto insurance company Metromile that went through in July, as well as remaining expenses related to the continued launch of new products in new states.
CEO Dan Schreiber predicted that the third quarter would be the peak for its losses, expecting fourth-quarter losses to narrow and keep narrowing going forward.
Second, and perhaps more important in terms of long-term implications, is the unstable loss ratio. The loss ratio measures how much the company pays out from each policy, and a lower ratio means the company keeps more money for itself. After trending lower in 2020, it has been creeping back up, coming in at 94% in the third quarter, up from 77% in 2021. An insurance company cannot be sustainable if its loss ratio is too high.
Management is confident that policy pricing informed by artificial intelligence will eventually be more accurate than any other way. It might still be too soon, but right now, it's not playing out that way.
Where the potential is
Until now, Lemonade's strategy was focused on growth. That meant a spending spree in all areas, from marketing and administrative through to new products and rollouts in new locations, all the way to Europe.
With the fortuitous meetup of having launched its expected slate of products at the same time that the cost of capital has risen, it's slowing its spend and turning toward improving profitability.
That doesn't mean growth is finished, as illustrated by the launch of Lemonade Car, its auto insurance product, in Texas in December. Lemonade Car is only available in four states: Illinois, Tennessee, Ohio, and now Texas. Not only is Texas the most populous state to offer Lemonade Car, it's one of the only states to now feature every one of Lemonade's products, expanding the opportunity from cross-sells and bundles.
Co-CEO Shai Wininger noted that Lemonade has experienced a 50% increase in bundled policies in areas that feature Lemonade Car. So this should be a major growth driver, even as Lemonade says it's moving its focus away from high growth.
A compelling valuation
Along with the plunging price comes a plunging valuation. In Lemonade's case, as the stock price falls and revenue surges, the price-to-sales ratio has declined to 4.
LMND PS Ratio data by YCharts
That could also be a value trap if you don't have confidence in Lemonade's further prospects. But I believe there's good reason to expect Lemonade to ultimately succeed.
Is it finally time?
Lemonade has made the decision to work on improving profitability at a time where that's what's prized in the market. Its Texas auto insurance launch could be a massive benefit as it makes that move.
Lemonade stock has plummeted below where I thought it would go, and it might finally have bottomed out. It's trading for what looks like a dirt-cheap price considering its enormous growth.
Even at these levels, Lemonade is still only for the risk-tolerant. In this market, there's no way to know which way it will go.
A lot of it will hinge on narrowing losses and an improved loss ratio. If those happen in the fourth quarter, the stock is likely to jump, and if they continue to get better going forward, Lemonade may end up being the growth stock investors originally thought it could be.
