Lemonade (LMND 1.64%) impressed investors after its July 2020 IPO. Its ability to apply AI to the sales and underwriting process showed the potential to revolutionize the insurance industry, and the stock surged as high as $188 per share before losing most of its value in the bear market.

Unfortunately, its potential has failed to translate into profitability, and a disappointing second-quarter report wiped out the stock's 2023 gains. With its market cap below $1 billion, many investors now wonder whether now is the time to double down on the AI stock or cut bait.

The financial performance

Lemonade's revenue for the first two quarters of 2023 was $200 million. This is a yearly increase of 112% versus the same time frame in 2022.

However, the net loss and loss adjustment expenses grew at a faster rate, increasing by about 166%. This led to net losses of $133 million in the first half of the year, improving slightly from the $143 million over the same time frame in 2022.

Still, the losses weighed on investors. The stock fell 22% following the announcement, and the drop continued in subsequent trading sessions.

The raised guidance was not enough to prevent this slide. In the report, Lemonade forecast revenue between $402 million and $408 million for 2023, an increase from the $392 million to $396 million range offered in the previous quarter. The company isn't liquidating its short-term investments so far, as the investment balance has been stable since the end of 2021.

Lemonade's continuing challenges

The catastrophe-related losses likely frustrated investors. That took its gross loss ratio, the ratio of gross losses from claims versus the gross earned premiums the company collects, higher. For the first half of 2023, the gross loss ratio was 90%, up from 88% for the same period in 2022.

Management noted on the Q2 2023 earnings call an improvement of eight percentage points in gross loss ratios over the last year, excluding catastrophes. Nonetheless, insurers are obliged to cover such costs, and the established insurance giants tend to target gross loss ratios in the 60% range or lower. Of the five types of insurance it sells, only renters insurance met this threshold in the second quarter.

With only $194 million in liquidity, its available cash will likely run out early next year if these trends continue. However, Lemonade can probably sell some of its $748 million in investments to raise more cash, so it has time to make improvements.

Still, the elevated gross loss ratios have remained a problem for the company, even in quarters without gross losses related to catastrophes. The inability to turn a profit has likely soured many investors on this stock. Moreover, legacy insurers have more time to research and invest in AI. Over time, this could erode the company's tech-related advantage in AI, reducing the company's chances to build a sustainable business.

It's best to avoid Lemonade stock

Given Lemonade's financial situation, investors should probably say goodbye to Lemonade stock, at least for now. Its AI-driven innovation could potentially transform the industry. And if it can reduce its gross loss ratios to the 60% range, the stock would probably surge much higher.

However, with its stubbornly high gross loss ratios, it is unclear whether Lemonade stock will ultimately be the best insurance stock to profit from AI. Management claims that loss ratios should improve as its AI systems crunch more data to improve their handling of insurance policies and loss claims, but Lemonade isn't there yet. Until the company proves it can consistently earn a positive net income, investors should probably stay away.