Insurance is an age-old industry, but that doesn't mean companies aren't trying new things. Insurance technology company Lemonade (LMND 2.31%) had its initial public offering (IPO) in 2020 and quickly became a favorite among retail investors.
Unfortunately, the stock collapsed amid the 2022 bear market. Had you invested $1,000 at its IPO, you would have only $216 today.
But don't assume that the stock is trash; many growth stocks sit well below their former highs. So is now the time to buy shares for an eventual rebound? Or is this potential disruptor barking up the wrong tree? Here is why Lemonade might not stay down forever.
A business model creating growth
Lemonade isn't your run-of-the-mill insurance company. It doesn't have a huge network of agents and brokers pressuring you for your business.
The company uses artificial-intelligence (AI) chatbots to deliver customer service and sales through a smartphone app. A traditional insurer has claimed it can save you 15% in 15 minutes. Lemonade's chatbots can sign you up in 90 seconds and pay a claim in as little as three minutes.
Lemonade is also a certified B Corp, which means it holds itself to a high social and environmental standard. It takes a flat fee from its premium pool and donates whatever is left to charity after paying claims.
Traditional insurance companies are financially incentivized not to pay claims, pocket all premiums that are not paid out to claimants. Lemonade's structure addresses this conflict of interest. The company has donated more than $6.1 million to date.
The model is winning over customers. Its customer base ended 2022 at more than 1.8 million, a 26% increase from 2021. That translated into $256 million in total revenue, up 100% from the prior year, on $625 million of in-force premiums (paid premiums on active policies).
The population isn't growing anywhere near 26% a year, so Lemonade is taking business from the competition. And the company is still launching new types of insurance, which should generate cross-selling opportunities.
Can Lemonade be profitable?
The insurance business is a game of balancing risk. Pricing is very competitive, so insurance companies try to offer coverage for as little as possible.
But the business loses money if you don't charge enough to cover your claims. Insurance companies express their efficiency through the loss ratio. For example, a company that charges $100 in premiums and pays out $60 in claims would have a loss ratio of 60%.
Lemonade's loss ratio has been quite volatile. It's been as low as 73% (lower is better) in the fourth quarter of 2020, yet it was 89% in the same quarter of 2022.
Its business isn't as large or diversified out as that of its competitors, so catastrophic events and rolling out new products could cause the loss ratio to vary. And Lemonade is aggressively spending on marketing to drive growth. Marketing expenses were $138 million in 2022, 54% of revenue.
Image source: Getty Images.
The two-sided cash burn from marketing and underwriting is the most significant risk to investors. Management had previously said losses would peak in 2022. But the company now forecasts losses of $245 million to $240 million in 2023, based on earnings before interest, taxes, depreciation, and amortization (EBITDA), exceeding 2022 losses of $225 million.
It's not ideal to see management fall short on a projection like that, but Lemonade has about $1 billion in cash on hand, plenty of money to continue funding the business for several years. Investors should watch for how much it loses in 2023 and whether that improves or worsens in 2024.
Less risk at this valuation
Lemonade shot to a lofty valuation in its IPO, which caused some debate about whether it was a technology company (higher valuation) or an insurance company (lower valuation). Wall Street has seemed to settle on the latter. The stock trades at just over book value today, even lower than its competitors.
The stock's valuation seems pretty straightforward. You can arguably give competitors such as Allstate and Progressive the benefit of the doubt and award them higher valuations for their stability versus Lemonade's volatility.
Still, the stock can be an excellent long-term investment because it's growing much faster than other insurance companies. Revenue doubled in 2022, and there is a substantial addressable market out there with plenty of room to grow, especially because Lemonade is just a tiny fraction of the size of its competitors.
ALL price-to-book value data by YCharts.
Realizing these potential investment returns will eventually depend on Lemonade turning a profit. Fortunately, the share price's huge decline has made the stock much less risky for long-term investors. Now could be a great time to build a position if you believe in Lemonade's execution and management's ability to steer it to profitability.
