Plenty of growth stocks plunged when the Federal Reserve started boosting interest rates a couple of years ago and investors' appetites for risk began to decrease. In many cases, the biggest concern about those companies was their profitability, and rightly so. After all, a rising-interest-rate environment isn't the best situation in which to raise capital, especially compared to the essentially zero-interest-rate environment that previously existed.
As a result, many growth companies have shifted their focus away from all-out expansion and toward profitability and sustainability. Here are two in particular that have recently given investors encouraging news on the profitability front, and that you might want to take another look at for your portfolio.
Impressive results, with profitability moving in the right direction
To say that the speed at which upstart insurance company Lemonade (LMND 2.12%) has scaled up its business is impressive would be an understatement. The company recently reached 2 million active customers, a feat that took current leaders in the industry like State Farm decades to achieve.
NYSE: LMND
Key Data Points
In the third quarter, its strong results continued, despite management pumping the brakes on its growth efforts to conserve capital. In-force premiums rose by 18% year over year. But the real story for Lemonade now is profitability.
Lemonade reported a loss ratio of 83% in the third quarter -- 11 percentage points of improvement compared to the year-ago period -- and management predicts that its newer cohorts of customers will have lifetime loss ratios well below management's 75% target. As a result, Lemonade's net loss contracted by roughly a third year over year, and management now anticipates achieving positive cash flow by late 2025. With $945 million in cash on the balance sheet, and less than $100 million in cash burn through the first three quarters of 2023, the company should have plenty of capital to fund its operations until it reaches profitability.
Tons of potential and the capital to grow
Neighborhood-focused social media company Nextdoor (KIND 3.52%) recently reported its third-quarter results, and the short version is that it is doing rather well despite this being a tough period for businesses that depend on advertising revenue. Weekly active users were up 6% year over year, and revenue increased by 4%.
NYSE: KIND
Key Data Points
However, there is still tons of potential for the business to grow. It is only a fraction of the size of the social media segment's leaders, and has barely begun to tap into its international growth opportunity -- but with 79% year-over-year international revenue growth, it's certainly on the right track.
Nextdoor has been losing money for some time, with an adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) loss of nearly $80 million over the past four quarters. But it appears management is finally getting serious about profits. The company plans to reduce its workforce by 25%, saving $60 million in personnel expenses annually, while simultaneously accelerating its user growth rate in 2024. If it can do this, management expects to break even on a free-cash-flow basis by the end of 2025.
No love from the market
One of the more interesting things about both of these companies is how cash-rich they are. And it's important to understand the context around just what this means.
Lemonade has $945 million in cash on its balance sheet, compared with a market cap of just $976 million. That implies that the market is placing barely any value on the business itself. Nextdoor is a similar example, with $540 million in cash at the end of the third quarter, not far below its market cap of $558 million. The market simply isn't showing much faith in either of these businesses or their management teams' ability to execute.
To be fair, a lot will still have to go right before either of these companies actually turns a profit. But if their management teams can achieve their profitability targets while they still have hundreds of millions of dollars remaining on their respective balance sheets, these stocks could become home runs for patient investors.
