Can Lemonade Turn Technology Lemons Into Lemonade?

Many companies have made the claim that they are going to revolutionize and improve an industry that is centuries old which will lead to fame and fortune. The latest company in this genre is Lemonade (NYSE:LMND), a Property & Casualty insurance provider that specializes in renters, homeowners, pet and life insurance. How LMND stock is different is best explained by the company, as my writing will fail to do the trick:

LMND stock logo displayed on smartphone laying on top of computer keyboard.

Source: Stephanie L Sanchez /

“Lemonade offers renters, homeowners, pet, and life insurance. Powered by artificial intelligence and behavioral economics, Lemonade’s full stack insurance carriers in the US and the EU replace brokers and bureaucracy with bots and machine learning, aiming for zero paperwork and instant everything. A Certified B-Corp, Lemonade gives unused premiums to nonprofits selected by its community, during its annual Giveback.”

That’s quite an ambitious mouthful. Lemonade went public in July 2020 at $29 per share and reached a high of $188 in January of this year. LMND stock has since retreated to the mid-$90 range.

Ceding Premiums

Another unique business decision Lemonade employs is ceding the majority of its premiums to reinsurers in order to reduce claim risk. Ceding is the insurance term for giving away your premiums to another insurance company so they can proportionally assume claim liabilities. Almost all insurance companies use this technique to some degree to reduce risk, but few insurance companies cede the majority of its premiums. LMND plans to cede 75% of its gross premiums.

This of course does not completely eliminate large amounts of claim risk that may occur in disasters for example. Nearly a fourth of Lemonade’s customer base is in Texas, which recently experienced a freak winter storm, sparking thousands of insurance claims.

Public Benefit Corporation

In order to set itself apart from their competition, LMND became a Public Benefit Corporation, or a B-Corp. This new form of corporate structure tries to find a balance between returns on capital and social good. They are legally required to consider the impact they have on all stakeholders such as employees, suppliers and the environment. It is unclear how this corporate election will affect the company’s financials or LMND stock, but at least they’re trying to do good!

Growth is Certainly A Factor

2020 was an impressive growth year for this early stage company as revenues increased about 40%. The number of customers grew 56% and exceeded 1 million by year end. Premiums per customer were $213 in the fourth quarter, a 20% increase.

But was it profitable growth? Of course not, the company is essentially still in high client acquisition mode. The elevated level of marketing expenses combined with necessary research and development costs means profits are many years away. Marketing expenses in 2020 even exceeded the amount of net earned premiums.

There appears to be a difficult path to profits ahead. Ceding away most of the gross premiums also diverts the steady earnings that come with it. If marketing expenses slow down, so will growth. Developing new product lines will also be costly.

Management Experience

None of senior management team has any experience in the insurance industry, at least as described in their SEC filings. LMND can call themselves a technology company if they want to, but that’s like saying Tesla (NASDAQ:TSLA) is a technology company and not a capital intensive automobile manufacturer. As legendary philosopher Sidney Deane once said, “You can put a cat in an oven, but that don’t make it a biscuit.” Don’t be fooled, LMND is an insurance company.

Successful insurance companies often have centuries of actuarial data to help with their underwriting process and predictions. Some of the largest insurance companies in America have histories that date back to the 1700s.

Valuation is Ridiculous

It’s hard to value start-up insurance companies with no track record or profits. Most insurance companies are valued at price-to-book value, typically in the range of 1-3x tangible book value. LMND stock trades at 9.5x trailing tangible book value. There will be no price-to-earnings ratio until the next U.S. President is elected, and possibly beyond that. Mature insurance companies usually trade at about 1x revenue and fast-growing insurers sometimes in the 2-3x range. LMND trades at 49x 2021 estimated revenues and 31x 2022 estimated revenues.

An entry point closer to book value ($15-$20) would take quite a bit of risk out of the story. Weather catastrophes, underwriting mistakes, volatility in interest rates, failures of reinsurers to make good on claims, and intense competition are just some of the many concerns insurance companies have to deal with (as well as 38 pages of other risk factors listed in LMND’s 10-K).

Kudos to the company for their entrepreneurship, creative technology vision, and efforts to create a company that supports the greater good alongside business profits – but good companies don’t always make great investments. LMND stock at today’s levels provides no margin of safety and is not a good time to buy.

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

Tom Kerr, CFA is an experienced investment manager and business writer who has worked in the investment and securities business since 1994.

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