As artificial intelligence (AI) has developed into a trendy topic on Wall Street, investors are clamoring to find ways to gain exposure to this new technology in their portfolios. While some businesses are scrambling to become associated with AI to boost their share prices, others were working on this tech long before 2023.
Lemonade (LMND 1.64%) is one such company. Its entire business model is based on using AI and data to underwrite and service insurance policies. But the stock has disappointed shareholders, and it's down 90% from its all-time high (as of July 11).
Should investors buy Lemonade stock on the dip right now? Let's consider both the bull and bear arguments for this fintech specialist.
Lemonade's bull case is compelling
Probably the most popular reason to own Lemonade is because of its fast growth. During the first three months of 2023, in force (i.e., active) premiums totaled $653 million, up 56% year over year. The customer count jumped 23% and now totals 1.86 million. And revenue more than doubled from Q1 2022. These figures are substantially higher than they were just a few years ago, indicating that it still has a huge runway for growth in the years ahead. Other companies are struggling with a difficult macroeconomic backdrop, but not Lemonade.
As I noted above, Lemonade uses AI throughout its business. There are 50 different machine learning models that handle different tasks all over the organization, and this automation is benefiting customers. Lemonade can approve a new policy application in as little as 90 seconds, while paying out a claim in three minutes. And everything is digital, bypassing the brick-and-mortar model that larger insurance incumbents have used.
The hope is that Lemonade can leverage its technological foundation to reach profitability soon. Management has set a goal to achieve a gross loss ratio, which measures claims paid relative to premiums earned, of 70% by 2027. In Q1, this metric came in at 87%, a sequential improvement over the previous two quarters.
If rapid growth leads to positive net income, it's not hard to imagine a scenario where Lemonade's stock price can skyrocket. Since its initial public offering, the shares are down about 70%, greatly underperforming the Nasdaq Composite. And they trade at a price-to-sales ratio of 4.1 right now, well below the stock's historical average of 27.2. This creates the opportunity for more upside for those investors who are bullish on Lemonade's long-term prospects.
Lemonade's bear thesis is stronger
Besides its disappointing track record and being a drag on its shareholders' portfolios for the past few years, I view Lemonade's lack of profits as a real risk that investors shouldn't ignore.
Revenue doubled in 2022, but its net loss widened by 23%. That's not indicative of a business that is leveraging its fixed costs and scaling well.
To be fair, the company could very well find its income statement in the black in the next few years, but it's anyone's guess as to the likelihood of this actually happening. If last year taught me anything, it's to focus my attention on businesses that are firmly profitable and in solid financial shape, because you never know when the macro picture will take a turn for the worse.
Lemonade also faces stiff competition from the major players in the industry, like Progressive, Allstate, and State Farm. There is merit to the argument that insurance is a commoditized product, meaning that rivals must compete mainly on pricing and customer service. Lemonade is attracting a younger demographic -- customers who can be lifelong customers -- but it's still tiny in the grand scheme of things. Making things more difficult is the fact that these bigger insurers are all investing heavily in their own digital capabilities.
It's easy to find Lemonade's charitable focus admirable (the company donates unclaimed premiums to various charities after taking a flat fee), but I'm not so convinced. Instead of trying to woo investors and customers by setting itself up as a Certified B Corp, maybe Lemonade should instead direct all of its attention toward simply creating the best insurance products on the market for policyholders at the lowest prices possible.
Just look at Costco. Do you think members would want the business to donate money each year to charities or continue to find ways to lower prices at its warehouses?
Taking all these factors into account, I believe that the bear case for Lemonade holds more weight. And that's why I'm not a shareholder.
