Lemonade (LMND +0.66%) shares have been under immense pressure recently, down 40% since the start of August (as of Aug. 24). This downward trend was propelled by a second-quarter earnings announcement that wasn't well received by shareholders.
The insurance stock currently trades at a price-to-sales ratio of 2.6. That's close to as cheap as they've ever been, so investors might be intrigued by the opportunity to buy a company focused on artificial intelligence (AI).
Let's take a look at one compelling reason that investors should buy Lemonade stock, as well as one reason to avoid it.
Mixing AI and insurance
Lemonade uses AI and machine learning to disrupt the traditional insurance industry. Thanks to its focus on technology throughout the entire organization and by avoiding having to use brick-and-mortar locations, the business says that customers can sign up for a new policy or get claims approved in minutes. It's a direct-to-consumer model that is more user-friendly, something that is needed in the digital age.
Probably unlike many AI start-ups that are receiving billions in funding, Lemonade has already found product-market fit by mixing AI and insurance. Even more impressive is the potential opportunity in the industry, as insurance is a massive market that has long been dominated by legacy providers with outdated systems and poor customer experiences.
Lemonade's growth speaks for itself. Between 2019 and 2022, the number of customers tripled, with revenue nearly quadrupling during the same time. And in the latest quarter, customers and revenue increased 21% and 109%, respectively, healthy gains given the uncertain economic environment.
What's encouraging is that Lemonade is attracting a younger demographic that can become lifelong customers. But management is also excited about the opportunity to cross-sell other insurance products over time. In fact, it's looking to get 25% of customers to have multiple products with the company by 2027, compared to just 4% last year and 60% for the incumbents.
NYSE: LMND
Key Data Points
Where are the profits?
Despite its outsized growth, Lemonade is far from being consistently profitable. In the second quarter, the net loss of $67 million was in line with the year-ago period. To get to positive earnings, management has set a long-term target of 70% for Lemonade's gross loss ratio, which essentially measures the amount of premiums paid out as claims. The lower the number, the better.
In the latest quarter, the figure came in at a disappointing 94%, driven by unpredictable severe weather that also affected the entire insurance industry. That's certainly a key factor that has pressured the stock price this month. For comparison, in the first quarter of this year, the gross loss ratio was 87%, so there is still a lot of progress to be made.
While unprofitable growth tech stocks might've gotten the benefit of the doubt in an era of loose Federal Reserve policy and low interest rates, I think the tone has changed somewhat. If 2022 taught investors anything, it's that owning businesses on strong financial footing and that actually generate positive net income should be a top priority when it comes to portfolio management. The fact that the near-term outlook for the economy is unknown adds risk for Lemonade shareholders.
Practicing patience
It's great to see this fintech business achieve tremendous growth with game-changing technology like AI and apply it to an industry that is ripe for disruption. As a result, Lemonade has sizable potential should it continue on its path of greater adoption. And I can easily see why growth-minded investors would jump at the opportunity to buy the beaten-down stock right now.
However, I'm staying away from Lemonade. Instead, I'll keep monitoring the company for signs it's inching toward sustainable profitability. I'll only consider buying the stock when I have confidence in Lemonade's financial situation.
