Lemonade (NYSE:LMND), the upstart insurance company, faces nothing but further losses as far as the eye can see. That effectively limits any potential upside for LMND stock.
Although the stock may not drop much as premium growth continues strong, the company’s future losses will keep a lid on the stock’s upside. In short, the company will likely have to grow into its present $4.3 billion market valuation.
This is what I suspected would happen in January. I wrote that LMND stock would fall 65% from $119.34 on Jan. 6 to $43.44 per share.
At first, I appeared to be wrong, as, by Jan. 11, LMND stock skyrocketed to $186.23. But immediately thereafter the price has drifted down and now rests at $70.07, as of mid-day Sept. 21.
I suspect that going forward the company will continue to grow its revenues significantly but losses will continue to mount. As a result, the stock is likely to drift lower or essentially tread water as its valuation metrics fall and work into today’s high levels.
On Aug. 4, Lemonade released its Q2 results for the quarter ending June 30 in a shareholder letter. Its quarterly gross revenue, which in insurance-speak is known as gross earned premium, was $66.9 million. This was up by 90% over Q2 2020 when it was at $35.3 million.
The prior quarter gross earned premium was $56.2 million, so this quarter it grew by 19%. That works out to an annualized growth run rate of 101%. The fact that the sequential growth is higher than the annual growth means the rate is accelerating. That’s the good news.
The bad news is that the company is still losing money hand over fist. Even after reinsuring 75% of its business, and keeping 25% on its books, Lemonade still posted huge losses. It had a net loss of $55.6 million and lost $40.4 million in adjusted EBITDA (earnings before interest, taxes, depreciation and amortization). Both of these are significantly higher than last year.
As if that was not enough, Lemonade also reported that its gross loss ratio was 74% vs. 67% last year. That measures the dollar value of claims from its renter’s insurance (56% of total premiums) and homeowners (30%) business as a proportion of total revenue.
Valuing Lemonade Stock
In my last article, I wrote that a normal valuation would be 1 times revenue for a slower-growing insurance company. To get to that state, I estimated the five-year forward revenue and compared it to today’s market value. At the time this metric was still too high at 2.4 times. That’s why I thought LMND stock would drop further.
But now that same measure is not so out of line. For example, let’s assume that eventually the company stops ceding out its gross premiums and that its annual revenue grows by 75% on average. That implies that its run-rate revenue of $267.6 million ($66.9 Q2 revenue x 4) will be 16.413 times higher (1.75^5). This means its 5 years’ forward revenue will grow to $4.392 billion (16.413 x $267.6 million).
That forecast is very close to today’s market cap at $4.31 billion at $70.07 per share today. In other words, the market seems to be anticipating that Lemonade will grow its premiums by 75% annually for the next five years. At today’s price, this reflects a non-discounted forward forecast of $4.39 billion in revenue vs. its $4.31 billion market cap or a ratio of 1.02 times.
What To Do With LMND Stock
Given this projection, it appears that at around $70 per share, LMND stock is fully valued, but not yet a bargain. I suspect that over time the market will watch to see if it is still on track to deliver 75% annualized compound revenue (i.e., premium earned) growth each year.
If it does better than that, the stock could rise proportionally, and vice versa. For example, as I have shown its Q0Q run rate growth rate is now significantly higher than 75% at 101%. If that keeps up, LMND stock could rise. However, the market also realizes that with higher base numbers the growth rate is bound to decelerate.
Therefore, I would not expect LMND stock to fall much further here, despite its growing losses. In fact, there is reason to believe, if revenue keeps accelerating, that it could rise 20% or so. As a result, this might be a good time for GARP investors (growth-at-a-reasonable price) to begin taking a stake in the stock.
On the date of publication, Mark R. Hake did not (either directly or indirectly) own any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.