A rising tide may lift all boats, but a rising stock market is leaving shares of many companies stranded. The S&P 500 is up 13% so far in 2023, but Lemonade (LMND -5.09%) stock is down more than 8% at the same time.
Investors have re-embraced growth stocks, even unprofitable ones, but somehow Lemonade isn't getting any investor love. Let's see what's going wrong and how it could change in a year's time.
When life gives you lemons...
I have to admit I didn't really get why the founders of Lemonade chose this cheery-sounding name for their insurance company, but it was explained that it's a parallel to the idea of when something bad happens, your insurance company makes it better, just like turning lemons into lemonade.
Why does Lemonade think it's better than the traditional industry giants? It's built on a digital substrate underpinned by artificial intelligence (AI)-based models. The company says the amount of data its algorithms can handle, combined with the interconnectedness of its systems, gives it much greater power than older kinds of risk-pricing models. Over time, as the model racks up data points and hones its accuracy, the advantages will become clear, according to the company.
That idea is resonating for the nearly 2 million customers who have chosen to purchase a policy with the digital insurance company. That number rises substantially each quarter and stands at 1.9 million as of the end of the second quarter, or 21% higher than last year. In a year from now, it should be comfortably more than 2 million and growing.
Revenue, gross earned premium, and premium per customer are increasing at a robust rate as well. Revenue increased more than 100% year over year in the second quarter, and gross earned premium, which management considers its top-line growth metric, increased 53%. There's likely to be some natural deceleration, but these growth rates should still be healthy next year.
On a sour note
Investors will often overlook net losses at a growth company if the model looks like it has strong disruptive potential and prospects of eventually becoming profitable. Some investors see that for Lemonade, but others are treading more carefully, mostly due to the growing loss ratio.
The loss ratio measures how much a company is paying out in claims from the premiums it collects. For example, if it's 100%, that means it's paying out all of its premiums in claims -- a financial disaster scenario. That helps explain why a lower ratio is vital to an insurance company's existence.
For all of its AI jargon, so far, the loss ratio is at best inconsistent. It came in at 94% in the second quarter, up from 86% last year and 74% the year before.
Management did a lot of explaining about how it's all going according to plan, and it did give some encouraging updates. It has said that older products have lower loss ratios, and in the 2023 second quarter, the loss ratio for its oldest product, renters insurance, was less than 50% for the first time. That was inclusive of catastrophes. Pet insurance loss ratio was in the 70% range for the first time.
Lemonade's progress isn't linear, but that shouldn't be surprising, and most companies' growth fluctuates. At this time next year, investors should expect Lemonade to demonstrate some progress, with a lower loss ratio. If it doesn't, it's cause for concern.
The other number that is spooking investors is the net loss, which was only marginally improved from last year at $67.2 million. Look for that to improve this time next year. Management already said it's working to generate more measured top-line growth while demonstrating sustained progress on the bottom line in the second half of 2023. It's planning to make that happen by proactively slowing down the top line until it has better systems in place to improve the loss ratio and the bottom line.
A sweet deal
Lemonade stock is trading at only 2.4 times trailing-12-month sales, which is incredibly cheap for the kind of growth it's demonstrating. That gives you a taste of just how disappointed investors are right now.
That's makes now a great entry point for investors who see the opportunity for Lemonade. But it's definitely only a buy for risk-tolerant investors. Once the loss ratio stabilizes, which could begin as soon as the coming quarter, Lemonade stock is likely to surge. But there are plenty of unknowns, and it could take longer.