Shareholders of insurance company Lemonade (LMND +1.14%) are no strangers to volatility. The stock's price has fluctuated between $10 and $25 per share over the past year and once traded for more than $183 at one point in 2021.
Why the volatility? Perhaps Lemonade is misunderstood. It's a business that uses technology such as artificial intelligence (AI) to turn the traditional insurance model on its head. Its chatbots do away with insurance agents and conduct business through a smartphone app.
Lemonade is a new competitor trying to carve out its place in a massive and ruthlessly competitive industry full of long-standing incumbents. Despite the challenges, there is enough promise to remain interested in the stock, which could have some big-time upside if all goes to plan.
Here is what you need to know.
Impressive growth with lots of expansion opportunity
Lemonade hasn't had too much trouble getting customers to try its insurance. The company has grown far more rapidly than its major competitors, though that's also comparing annual revenue of under $1 billion to companies doing $55 billion. However, the fast growth does signal that Lemonade is taking business from others, and its site calls out a list of competitors with percentages of where its business has come from.
Growth in customers is strong, too. Lemonade's customer count grew to 1.9 million in the second quarter, up 21% from the prior year. Lemonade started in renters insurance and recently began offering auto, pet, and life insurance. The resulting cross-selling activities should contribute toward revenue growth for the foreseeable future.
LMND revenue (quarterly YoY growth) data by YCharts. YoY = year over year.
Lemonade's successful growth efforts should be exciting to investors because there is a tremendous amount of opportunity for the company. The global property and casualty insurance market is worth an estimated $1.8 trillion, so its market share is tiny right now.
Lemonade's small size could make for a rocky ride
While the growth is exciting, Lemonade faces the challenge of enduring the heat of competition financially. The company, at its current size, is a minnow swimming in shark-infested waters. That might not always be the case, but investors must watch its finances closely.
On the one hand, Lemonade seems to be improving at analyzing risk as it gets data from claims. The loss ratio, which compares how much insurance companies get in premiums versus what's paid out in claims, has declined across product categories over time -- a good thing.
Source: Lemonade
On the other hand, you'll notice that homeowners insurance excludes catastrophic events. That's because the total combined ratio was a mediocre 94% for the whole company when you factor that in. Catastrophic events, such as a wildfire or hurricane, can tank a company's profits because they cause a surge in claims that its risk models couldn't detect.
You could argue that a giant company like Allstate has a massive business and that a hurricane or other event in one market probably won't set the business back in the long term. But for Lemonade, these events can have a significant impact because the company is too small to be diversified. Its insurance losses nearly tripled from the same quarter a year ago due to serious storms.
Lemonade has gone through just over $92 million through six months of 2023 but has almost $1 billion in cash and investments on its balance sheet, so it won't run out of money anytime soon.
Is the stock a buy?
Management is guiding for nearly $200 million in losses as measured under earnings before interest, taxes, depreciation, and amortization (EBITDA) this year, so the business isn't near profitability yet. The market might not favor unprofitable companies in the short term, so investors should acquire shares slowly if they want to own Lemonade.
On the other hand, the investment potential is compelling if it can continue growing and operate with a more stable loss ratio. The financial losses are an eventual concern, but the company's excellent cash position should give optimistic investors confidence in holding the stock for the time being. Lemonade is a great candidate for a long-term and diversified growth stock portfolio.
