Bull Market Buy: You Haven't Missed Out on Lemonade

Investors could debate whether or not we’re in a bull market right now. But leaving technicalities aside, the S&P 500 is up close to 16% this year, and while it gave back some of its earlier gains that put it close to a bull market from all perspectives, it has held on to most of its year-to-date gains.

Many stocks have soared this year and plateaued, just like the broader market. But Lemonade (LMND -1.88%) is down again after disappointing investors in the second quarter, giving up all of its year-to-date gains to be flat in 2023.

That means you haven’t missed out on Lemonade’s potential, and at the current price, it’s a real bargain.

Why Lemonade initially dazzled investors

Lemonade garnered attention at its initial public offering three years ago. It presents itself as a modern alternative to traditional insurance, which by default is incentivized to deny consumer claims.

Lemonade offers a customer-friendly, all-digital interface to minimize human interaction and make it less tedious and frustrating to file claims. It also came up with a model of giving policyholders the opportunity to donate remaining funds from their policies to charity at the end of a policy year. 

This has proved popular with the company’s target market. It adds thousands of customers every quarter and ended the second quarter with 1.9 million, a 21% year-over-year increase. In-force premium, Lemonade’s favored top-line metric, increased 50% year over year to $687 million in the quarter, and the average premium per customer increased 24% to $360.

Lemonade uses artificial intelligence (AI) throughout its operations, giving it certain advantages over legacy insurers, which are trying to catch up. It onboards most customers and pays most claims through an online chatbot, and it uses AI to price policies and examine its markets.

Those are its advantages, but in other ways it’s still catching up to traditional insurance companies.

Why investors have bailed

While initially it looked like Lemonade had the tools and model to seriously disrupt the insurance industry, so far, it’s not playing out quite that way.

For all its fancy AI footwork and consumer-centric experience, it has not managed to turn a profit. And losses are big. Most traditional insurance companies have been around for decades, if not more than a century. They have their models and algorithms down pat and generally post strong profitability. 

The big issue centers around what’s called the loss ratio, a metric that measures how much of a customer’s policy, on average, the insurer pays out in claims. Clearly, a lower loss ratio is to be desired, and at a certain ratio the company becomes profitable.

Investors have given Lemonade time to bring its ratio down, but rather than mostly consistent downward movement, the loss ratio has been all over the place. The market rewarded Lemonade in the first quarter after the loss ratio fell by 3 percentage points from last year to 87%, but it was up by 8 percentage points over last year in the second quarter to 94%. Keep in mind that at 100%, it’s paying out everything in claims. 

Management says that new products typically come with higher loss ratios as it figures out pricing and tries to generate adoption, and the company was able to demonstrate very low loss ratios for its older products. The loss ratio on its renters insurance, its oldest product, was 47% in the quarter, and for its pet insurance it was 77%.

Investors are disillusioned, but there’s reason to hang on

There’s only so long a company can go on without turning a profit. But there are some points in Lemonade’s favor.

One is that it doesn’t need to borrow money to keep going. That’s often the reason many companies go under; they simply can’t borrow any more money, but aren’t making enough to survive. 

It recently struck a deal for another company to pay for its up-front acquisition costs, with Lemonade paying it a kind of commission. But Lemonade doesn’t have any debt, so it’s in a healthy financial position for now, giving it time to get its model to yield results. 

Buying Lemonade stock is still risky, and it’s not suitable for all investors. It’s taking a long time to demonstrate the progress investors want to see, and every step forward has been followed by a few steps backward. But when it does turn a corner, the stock could skyrocket.

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