Is Lemonade Stock a Buy?

Lemonade (LMND -1.61%) has attracted a lot of investor interest due to its artificial intelligence (AI)-based insurance business. The company promised efficient underwriting and was an early adopter of chatbots to handle insurance purchases and claims.

The company rose from its initial public offering (IPO) price of $29 to $69 per share on its first day of trading and rose to $188 in January 2021 amid investor euphoria. Although the company was getting excellent customer and premium growth, it struggled with profitability, and the stock soon collapsed as investors fled high-risk growth stocks amid rising interest rates and inflation.

Lemonade recently announced earnings and continues to show positive momentum on its profitability metrics. After years of negative investor sentiment, is the squeeze on Lemonade finally worth it?

Lemonade is growing fast, but losses have held it back

Lemonade has not lacked growth. At the end of the second quarter, the number of customers was almost 2.2 million, a 14% increase from last year. Over two years, the number of customers increased by 37%.

While its growth has been solid, it has come at the cost of higher expenses and claims costs. Lemonade has entered several insurance markets in recent years, including home, pet and auto insurance. As a result, the company experienced more and more problems while using its risk pricing models.

In the insurance industry, the best companies have excellent underwriting models that balance the rewards of insuring certain risks and price them accordingly. One metric by which we can see Lemonade’s progress is the net loss ratio, or the percentage of premiums earned that go toward paying claims costs.

Lemonade’s management set a target of 75% loss and has been quite far from that target for the past few years. In the past two years, Lemonade’s net loss rate has been 97% and 89%, which has been a point of concern among investors.

Things have been looking up for Lemonade recently. The net loss ratio has remained constant over the past three quarters, reaching 79% in Q2. This is slightly above management’s target, but shows that the company has made progress after years of high loss rates. This trend shows that the company continues to tweak its underwriting model and premiums charged, and that’s exactly what investors want to see.

It also continues to grow its customer base and premium per customer, which is important as it sells its newer offerings to existing customers. In Q2, premium per customer was $387, up 7.5% from last year. However, you should note that Lemonade continued to lose money and posted a net loss of $57 million in the quarter, an improvement from the $67 million loss a year earlier.

Should you buy lemonade?

Analysts estimate that Lemonade’s revenue could grow to $514 million this year and $654 million in 2025, while its loss per share will narrow from $3.02 to $2.48 next year. As a result, the stock is trading at 1.72 times one-year forward sales and 2.36 times this year’s sales, which is the low since the 2020 IPO.

LMND PS report data by YCharts

I’ve been wary of lemonade for a while because of its higher loss rate. Three consecutive quarters of loss rates below 80% is a positive trend, and investors want to see this continue to confirm that Lemonade’s recent success is sustainable and not just a fluke.

Investors with a higher risk tolerance may want to consider starting a small position today based on the cheaper valuation. However, more conservative investors should wait for confirmation of additional loss rate and improvement in net losses over the next few quarters, which could be the turning point that long-term investors are looking for.