Lemonade Stock Is Attractive, but Valuation Remains a Question Mark

Fast-growing tech companies have disrupted almost every industry at this point, and now they’re coming for insurance. Lemonade (NYSE:LMND) is leading that charge, and as a result, LMND stock has benefited.

It's a Compelling Company, but Now Isn't the Time to Buy Lemonade Stock

Source: Piotr Swat / Shutterstock.com

Indeed, Lemonade’s initial public offering was one of this year’s hottest, as LMND stock climbed the market on its first day of trading. It’s not hard to see why, though

After all, Lemonade has the same characteristics as so many tech winners of recent years. It has a massive addressable market, and it’s posting impressive growth. Lemonade is innovative, and is using existing tech to attack its markets. Meanwhile, incumbents are saddled with legacy systems — and legacy strategies.

The concern is whether that big IPO pop prices in too much of the potential here. Lemonade has a long way to go to even sniff profitability. It’s an innovator in the insurance industry, but it’s still in the insurance industry.

That said, a recent pullback does help the cause somewhat. But, personally, I’d like to see LMND stock come in a bit more before jumping in.

The Case for LMND Stock

It’s worth emphasizing: there’s a lot to like here. And overall, Lemonade has begun by targeting mostly smaller markets.

Its initial focus was on homeowners and renters insurance — both areas favored by tech-savvy millennials — and where incumbents probably haven’t invested in their offerings the way they could have. More recently, Lemonade added pet insurance, a high-margin and growing niche that too seems well-suited for the model.

In turn, we saw in the company’s second-quarter results how successful the company has been in the early going. What the company calls “In Force Premium” — essentially, an annualized total of premiums paid by customers at the end of the quarter — more than doubled year-over-year. So did revenue, and customer count was the key driver, rising 84%.

Lemonade saw profitability metrics strengthen as well. Notably, gross loss ratio — how much the company pays out versus how much it brings in — improved dramatically.

To be sure, the novel coronavirus pandemic likely played a role in suppressing claims. But overall, Q2 shows the progress Lemonade is making. It’s acquiring new customers at a rapid rate, charging those customers higher premiums (+17% year-over-year) and doing a better, job of underwriting. That said, it’s the kind of quarter investors like to see from a growth name.

Managing the Pandemic

Aside from the numbers, there’s a key quote from the second quarter shareholder letter that is worth highlighting. The company wrote:

“With millions of people fired or furloughed and billions in lockdown, Lemonade entered Q2 on a defensive footing… Then, we braced for impact. We expected to see a spike in churn, a drop in demand, and a hit to our cash flow. None materialized… Trajectories that we’d seen prior to the pandemic – rapid growth, improving marketing efficiencies, declining loss ratios – all continued their forward march, apparently unperturbed by the contagion.”

This, too, is what investors like to see. Lemonade isn’t necessarily a “pandemic winner” like so many other tech names, though it might receive some tailwind from consumers using extra free time to shop for better insurance policies and rates. But, at the least, a company with big-time growth potential hopefully can manage external headwinds.

There hopefully won’t be any bigger headwind than what Lemonade saw in Q2. But if there were to be, the company — per both its numbers and its commentary — managed beautifully during the last one.

Paying for Potential

So, what’s the case for not owning LMND stock at this point? Valuation is one potential sticking point.

To be sure, I’m not the kind of investor who is unwilling to pay up for a quality growth name. And the performance of the markets in recent years only has strengthened that viewpoint.

That said, it’s difficult to really get much of a read as to what Lemonade is worth. This is a company that generated just $30 million in revenue in the entire second quarter.

It’s not close to profitable even on an Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) basis. Investors often use book value as at least a check on valuation when it comes to insurers. But Lemonade’s book value is negative.

Certainly, there’s a huge opportunity here, but competition will be stiff from both other startups and established players. Meanwhile, even after a pullback LMND stock still sits more than 85% above its initial offering price of $29.

Long-term, I’m intrigued by the Lemonade story. Short- to mid-term, though, I can’t help but wonder if I need to pay double the price at which the company itself sold stock less than two months ago.

Meanwhile, given the current pullback, it’s far from impossible that a cheaper price will be on offer soon. And any growing pains in the near future may send the stock tumbling even further.

To be sure, this is a great story. And, over time, I believe LMND stock will be a winner. I’m not yet convinced, however, that it needs to bought right now.

On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.

Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now. As of this writing, Matt did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media, https://investorplace.com/moneywire/2020/09/story-attractive-lmnd-stock-could-use-pullback/.

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