Insurance tech company Lemonade (LMND -2.12%) has been the subject of fierce debate since its 2020 initial public offering. First valued like a technology company, Lemonade soared to huge returns before plunging 92%, arriving at a valuation comparable to traditional insurance stocks.
The market can be inefficient, especially in the short term, and capitalizing on Wall Street's mistakes can produce great returns. So, is Lemonade a technology stock trading at an insurance company's price tag? Or was it a bull market mirage?
Fortunately, the question could be irrelevant. Lemonade's risk-reward potential today makes it a table-pounding buy regardless of how Wall Street values the business. Here is why.
Lemonade is a refreshing alternative in the insurance industry
Lemonade approaches insurance in a new way. Rather than using agents to handle policyholder interactions like sales and claims, Lemonade uses AI-powered chatbots. You can sign up for a policy in 90 seconds and file a claim in three minutes, all through a smartphone app.
Traditional insurance companies are financially motivated to work against you; paying less in claims leaves more premiums to fall to their bottom line. Lemonade caps its take as a flat percentage of premiums, and anything left over after paying claims is donated to charity. This aligns Lemonade with policyholders and resonates well with younger customers, its target audience.
Insurance is a slow and steady industry that is dominated by incumbents such as GEICO, Progressive, and Allstate. Lemonade had 1.8 million customers at the end of 2022, representing a 27% year over year gain in the fourth quarter. It's a sign that it's taking business from its (much) larger competitors. The million-dollar question is: Will it continue doing so?
Trying to catch up to its peers
Lemonade commanded a tech-like valuation during the bull market in 2020 and 2021, but the core business is still insurance. One could probably count on the stock maintaining a valuation similar to other insurance companies. But that's not necessarily bad news. Below, you'll see how its price-to-book-value (P/B) ratio compares to that of Progressive and Allstate:
LMND price-to-book value data by YCharts.
Lemonade has fallen so much that it's cheaper than traditional insurance companies. One could argue it's deservedly so because it is still losing money. Operating losses were $163 million in 2022 on just $256.7 million in revenue. Progressive, for example, made $6.8 billion in operating profit on more than $49 billion in revenue.
Lemonade is spending on marketing to drive growth, and its underwriting isn't efficient enough yet. It's entering new product categories and is small enough that a rough patch of large claims (after an ice storm in Texas, for example) can skew its loss ratio, which measures premiums received versus claims paid (lower is better). Investors hope it will become profitable as it grows and improve its underwriting performance.
Growth is strong, and cash is plentiful
Unfortunately for those looking for quick rewards, Lemonade will probably take years to establish itself as a consistent competitor to traditional insurers and a sustainable investment. The good news is that it is financially sound and has enough cash to operate for quite a while. It has more than $1 billion in cash and short-term investments on the balance sheet (and zero debt), far exceeding its operating losses in 2022 of $163 million.
LMND cash from operations (TTM) data by YCharts. TTM = trailing 12 months.
Meanwhile, management targets an average of 25% annual premium growth over the long term. Investors should follow the company's loss ratio and cash burn each quarter to see that things are heading in the right direction.
It might take time, but the wait could be worth it. Lemonade could be a hypergrowth insurance stock if it can repeatedly increase premiums by 25% a year. Once the market believes the business is sustainable (and eventually profitable), shareholders could see a boost in the shares and a higher valuation.
