Lemonade(NYSE: LMND) stock just hit a 52-week high after third-quarter earnings. In recent months, after-earnings pops have always been followed by a plunge to right back where they started. Will this change? The insurance technology company reported stellar results, so this could stick, and Lemonade stock might finally be on its way up. Let's go through the results and what they mean for Lemonade's future.
Top line: Accelerating
Lemonade is an insurance company, and it measures its growth and success somewhat differently than other kinds of companies. Revenue and profits are still important measures, but Lemonade's favored top-line metric is in-force premiums (IFP), or the average of current policies in place during the quarter. Because policies are paid for by customers, but not all of it becomes revenue, this is the metric that gives investors a more accurate picture of the story.
IFP increased 24% year over year in Q3, an acceleration, and revenue increased 19%. Total customers increased 17% year over year to 2.3 million, and premium per customer increased 6%. Lemonade's strategy is to attract younger customers and grow with them, which leads to more policies and more high-priced policies over time, and it's working.
Bottom line: Better than expected
Lemonade is a young company, and it hasn't become profitable yet. It went through a launch phase when it expanded from renters insurance to homeowners, pet, life, and auto, and it's still rolling out across the U.S. It also has some international operations.
Investors have been displeased with the pace of improvement, but management is confident that over time and with scale, the benefits of digital systems will kick in, and Lemonade will become profitable. You can already see some results, as the top line is growing without increased headcount. At the same time IFP was up 24%, headcount was down 7%.
Net loss widened from $62 million last year to $68 million this year, but loss per share was better than Wall Street's expected $1.03 at $0.95. Operating cash flow was positive $16 million, and net cash flow, which it defines as the change in total cash, cash equivalents, restricted cash, and investments, was $48 million.
Lemonade is still spending a torrent on marketing as it gets its name out, and it's expecting to increase marketing expenses next quarter. So while the scale is leading to profitability on one level, it's not enough -- yet -- to overtake expenses and turn the company profitable. Right now, analysts are still modeling Lemonade to be unprofitable through at least 2025, but management is expecting adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to turn positive in 2026.
Loss ratio: A massive win
Investors are keenly watching Lemonade's loss ratio, because that's the biggest demonstration of its long-term viability. The loss ratio simply measures how much of a policy is paid out in claims, so lower numbers are better. This number is tied to the company's underwriting capabilities and the ability to match rate to risk.
Management has touted that it's a digital company based on an artificial intelligence (AI) infrastructure, and that the moves away from human intervention in favor of machine learning and connected systems would eventually lead to improved algorithms that legacy insurers can't beat. It's taken a while, but it looks like that might be happening.
I said last week that the market would be happy if the loss ratio was below 80%, where it's been holding for the past three quarters and would be a 4-percentage-point decrease year over year. It came in at 73%, or 10 points lower than last year. The trailing 12-month loss ratio was 77%, an 11-point improvement year over year, and this was the fifth straight quarter of sequential improvement in the 12-month trailing number.
Image source: Lemonade.
Management has been changing its policy makeup to become less susceptible to catastrophes. It's cutting down its exposure to homeowner's insurance, especially in California, and moving forward with rolling out auto insurance throughout different states. That's contributing to the better loss ratios, and it should continue as it keeps up these trends.
Stock: Moving in the right direction
It's not easy to value Lemonade stock because it's not a typical retail or tech stock, and it's far from a typical insurance company. The price-to-earnings ratio or price-to-cash-flow ratio won't work with an unprofitable stock, and a price-to-sales ratio is less reliable because revenue isn't the base top-line metric.
That said, Lemonade stock trades at a price-to-sales ratio of 3.4, which is well below its three-year average of 6.4. That's also quite reasonable for a fast-growing stock.
Don't expect Lemonade stock to skyrocket overnight. It isn't likely to move up in a linear fashion. Instead, it will likely reflect the trajectory of the loss ratio as Lemonade finds its footing. If you can handle some potential volatility and have a long-term horizon, now might be a good time to take a chance on this stock.
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Jennifer Saibil has positions in Lemonade. The Motley Fool has positions in and recommends Lemonade. The Motley Fool has a disclosure policy.
