Lemonade (LMND 1.64%) uses artificial intelligence (AI) throughout its entire business, helping to better analyze insurance risk, approve policy applications, and manage claims. It's no wonder this tech focus helped propel shares 70% higher through the first seven months of 2023, crushing the gains of the S&P 500 and the Nasdaq Composite index.
But in the month of August, shareholders have soured on the stock after its most recent financial update. Let's take a closer look at what's going on with this fintech to help decide if the stock is a buying opportunity right now.
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Recapping the second quarter
The AI-powered insurance provider beat Wall Street expectations last quarter. Revenue more than doubled year over year to $105 million, with the loss per share of $0.97 showing a notable improvement. And management said full-year revenue would come in at $405 million (at the midpoint of its forecast), better than the average analyst estimate.
Moreover, Lemonade's in-force premiums and customer base soared 50% and 21%, respectively, from Q2 2022. These growth rates are impressive no doubt, so it might be shocking to see that Lemonade's stock has been under immense pressure. These figures in most other contexts would send shares higher, but that hasn't been the case.
Shareholders are probably fixating on Lemonade's rising gross loss ratio, which measures the amount paid out in claims as a percentage of premiums collected. During Q2, this was 94%, up meaningfully from 86% in the second quarter last year. As is clearly evident, Lemonade's gross loss ratio is heading in the wrong direction. And it's a far cry from the leadership team's long-run target of 70%.
"The second quarter was marred by the unseasonable weather catastrophes (CATs) that weighed on our gross loss ratio," the Q2 shareholder letter reads. More specifically, the business blames things like hail, straight line winds, tornadoes, and thunderstorms, which are difficult to accurately predict and underwrite when approving policies.
What's encouraging is that elevated losses weren't necessarily specific to Lemonade, as other insurers faced similar challenges. And excluding the impacts of CATs, the gross loss ratios for various products have been trending lower over the past several quarters.
Nonetheless, this is certainly a concern for investors.
Why I'm not a shareholder
Despite the strong financial results, Lemonade's stock is getting hammered -- down more than 20% this month, wiping out much of this year's gain. After the huge sell-off, shares currently trade at a price-to-sales (P/S) multiple of 3.3, significantly below the historical average P/S ratio of 26.6.
Even keeping in mind Lemonade's outsized growth potential, that discounted valuation isn't enough to convince me to buy the stock. I'm sure I'm not the only one who questions if Lemonade will ever become profitable. Its most recent financials showed that from a risk-assessment perspective, the business still has a long way to go to reach its goals in terms of the target loss ratio of 70%. And until Lemonade can lower losses on its policies, bottom-line profitability will be hard to come by.
I understand that predicting weather events is challenging. But if Lemonade is experiencing losses like the rest of the insurance industry, then what's the advantage that its 50 machine-learning models bring to the table? Consequently, shareholders are probably wondering why Lemonade's use of data and AI models can't better assess risk.
Through the first half of 2023, the company was presented with a wonderful opportunity to demonstrate its competitive advantage in a ridiculously competitive industry. But its technology hasn't delivered as promised. Maybe that's why the stock is getting battered. Investors are becoming more skeptical of Lemonade's prospects.
