Lemonade Will Never Get Profitable Until It Reduces Underwriting Losses

Lemonade (NASDAQ:LMND) is trying to make a big splash with millennials with home and pet insurance. But it is mired in losses and won’t be able to dig itself out without lowering its underwriting losses. My projection is that Lemonade stock — despite its popularity with Robinhood’s young traders and Wall Street analysts — is stuck in a deep bog of insurance losses.

Lemonade logo displayed on smartphone laying on top of computer keyboard.
Source: Stephanie L Sanchez / Shutterstock.com

I wrote a little bit about this last month. But I wanted to take a closer look this month. One of the unique issues that I found out was that Lemonade has subpar insurance underwriting.

Unless Lemonade can fix this issue, much less its general and administrative cost issues, it won’t make a profit.

Fixing the Combined Ratio

For example, one of the key ratios that property and casualty insurance companies use to compare each other is what is called the combined ratio. This essentially measures the insurance underwriting losses and general administrative expenses as a percentage of premiums received.

The best insurance companies have combined underwriting loss ratios and expense ratios below 100% of premiums.

The most important part of this is the insurance underwriting losses. And that’s the rub with Lemonade stock. In the company’s “inaugural” shareholder letter for the second quarter (since going public in July), Lemonade’s net loss ratio was 70% of premium based revenues. This is on page 8 of the shareholder letter.

That is exorbitantly high. For example, Assurant (NYSE:AIZ), a similar home insurance company has a net loss ratio of just 39.8%. You can see this on page 7 of their financial supplement in their most recent quarterly returns.

Here is a simple explanation of what this means. Lemonade and Assurant both take in insurance premiums. But people have claims and submit their claims to the insurance companies. Maybe their house burnt down. Maybe their goods were stolen. Then the insurance company has to cover those losses. This is separate from their regular operating general expenses.

The problem is those losses take up a huge share of the revenues Lemonade makes from its premiums. It has either priced its products wrong or is experiencing an adverse selection of its clients. Compared to Assurant, Lemonade really does not seem to have a chance of making a profit.

At least there is some good news in this regard. Last year its net loss ratio was 74% of premiums. But going from 74% to 70% in one year is not going to get it down to 40% anytime soon.

What To Do With Lemonade Stock

Marketbeat.com says there are six analysts who covered Lemonade stock in the last 12 months. Their average price target is $86.00 per share of LMND stock or 67% above today’s price of $51.58 (Oct. 2).

But this is not the whole story. For example, some analysts have written critical reports on the company. For example, Marketbeat says that Goldman Sachs came out with an inaugural report on LMND stock with a sell rating on July 27.

In addition, four of the other five reports were with an equal weight or market perform type rating. Those are not glowing recommendations.

The problem, as I pointed out in my last article is that Lemonade is expected to post huge per share losses this year and next. How huge? The company is forecast to lose $4.27 per share this year and make negative $2.97 in 2021, according to Yahoo! Finance.

I just can’t see how these analysts are coming up with the average target price of $86.00. The only possible way this works is if in five or six years, Lemonade makes significant profits. Those profits, discounted to the present, would have to outdo its significant underwriting losses.

In other words, you have to have faith. Somehow Lemonade will forget out how to get rid of its adverse selection and other underwriting losses.

That is not a sound way to invest in a company. Most investors will look elsewhere to find a less speculative way to make money.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.

Article printed from InvestorPlace Media, https://investorplace.com/2020/10/lmnd-stock-wont-rise-without-drop-in-underwriting-loss-ratio/.

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