2023-07-21 14:21:03 ET
Summary
- Lemonade uses AI to provide low-cost insurance and has cheaper costs due to the lack of overhead from paying a network of agents, setting it apart from competitors.
- Despite being a younger company with a smaller data cache, Lemonade's fundamentals are strong, and it has nearly $1 billion to grow its customer base and improve underwriting.
- The company's stock is now valued as an insurance stock, making it attractive for long-term investors despite financial losses, given its rapid growth and strong cash position.
Insurance company Lemonade ( LMND ) has been a poster child for stock market volatility over the past few years. Investors are trying to determine a fair price for a stock that's swung between $10 and $180.
I first wrote about Lemonade a couple of years ago. The company has made progress since then, both in product and financials. You can find that analysis here , though I didn't foresee what last year's bear market would do to the stock's price.
That said, Lemonade has rallied well off its lows since 2023 began. Still, for a company that gets swept into the artificial intelligence bucket, the hype around AI has yet to necessarily move Lemonade as much as some other names out there.
That's okay.
Here is why Lemonade can be a solid investment over the next five years (or longer) -- but only if you have the patience to see it through. Let's dive in.
Is Lemonade an AI company? Sort of…
To begin, we should explore what Lemonade is. The company uses artificial intelligence throughout its business to provide low-cost insurance to customers in several products, including Renters, Homeowners, Pet, Life, and Auto.
All insurance companies use machine learning and algorithms to analyze risk and underwrite policies, so this isn't Lemonade's secret sauce . But Lemonade leaned into AI to service customers, which currently sets it apart from its competitors, who built their businesses on the outdated agent model.
Lemonade works through a smartphone app, utilizing chatbots to serve customers and process claims. GEICO used to advertise that "15 minutes could save you 15% or more". On Lemonade, customers can get a policy in as little as 90 seconds and get paid for a claim in three minutes.
Just as important, Lemonade has inherently cheaper costs because it doesn't have to deal with all of the overhead that comes with paying a network of agents. The company is still working to drive costs down; it's creating synthetic agents to lower its customer acquisition costs, which currently take about three years to pay back.
Fundamentals are strong, while the company masters its craft
One of Lemonade's problems is that it's a much younger company than its competitors, which means it has a smaller cache of data to underwrite. Its small sample size and footprint mean that a mistake can significantly impact its underwriting performance, illustrated in its loss ratio , what Lemonade pays in claims versus what it collects in premiums.
Lemonade loss ratio and premium growth. (Lemonade 2023 Q1 shareholder letter.)
Investors should monitor this moving forward. Lemonade isn't profitable at the moment, and improving the loss ratio will play a role in changing that. The company has 1.85 million customers, which needs to be higher so that the occasional catastrophe doesn't hurt the company so much.
Lemonade is burning about $49 million in cash every three months, but the good news is that it has just under $1 billion in cash on its books. In other words, patient investors have plenty of time to let Lemonade grow its customer base and improve its underwriting without running out of cash.
The valuation looks right
The uncertainty of valuing Lemonade as a technology company versus insurance could have contributed to the stock's volatility.
I've illustrated below how much Lemonade's valuation stretched away from other insurance companies in 2021. Wall Street has seemingly settled on Lemonade being an insurance business, and the dramatic pullback has put it on par with its peers.
Investors shouldn't expect Lemonade to retrace to previous highs anytime soon, but it does set up investors for annual returns that resemble its organic growth. I think the stock can appreciate along with the business now that the hot air has left the balloon.
In this sense, the stock seems attractive for long-term investors. While Lemonade needs to make some financial progress (like making money), the company grew premiums by 56% year-over-year in Q1 and its customer count by 26%. One could argue that its rapid growth offsets the company's financial losses, especially considering its strong cash position.
What could go wrong?
Lemonade is a promising potential disruptor in a massive and arguably outdated insurance industry, but investors should keep the stock on a tight leash.
The company's much larger incumbent competitors could eventually see Lemonade's success and copy parts of its business model (the highest form of flattery). Would competition do away with the agent model completely? It's hard to tell, but you must monitor the industry if you hold Lemonade long-term.
However…
When you factor in the possibility that Lemonade will likely be profitable and do far more business down the road than today, I think investors have a path to enticing investment returns moving forward -- even if the journey is volatile.
Editor's Note: This article was submitted as part of Seeking Alpha's Best AI Ideas investment competition , which runs through August 15. With cash prizes, this competition -- open to all contributors -- is one you don't want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!
For further details see:
Lemonade: A Sweet Taste Of Upside For The Right Investor