Lemonade Stock: Bear vs. Bull

Lemonade (LMND -0.06%) went public at $29 per share in July 2020. The online insurance company's stock opened at $50.06, continued to rally, and eventually hit an all-time high of $182.90 last January.

But over the past year, Lemonade's stock has plunged back to its IPO price. Concerns about its slowing growth, widening losses, its takeover of the struggling auto insurer Metromile (MILE), and its high valuations all made it a weak investment as interest rates rose.

Should investors consider Lemonade's return to its IPO price to be a good buying opportunity? Let's review the bear and bull cases to find out.

Image source: Getty Images.

What the bears will tell you about Lemonade

Lemonade simplifies the byzantine process of buying insurance with a single app that runs on AI-powered chatbots and algorithms. It initially only offered renters and homeowners insurance, but it subsequently added term life, pet, and auto insurance policies.

The bears will point out that Lemonade's limited user base, its decelerating growth, its widening losses, and its narrow moat make it a flimsy investment.

Lemonade ended last quarter with 1.36 million customers. That makes it a lot smaller than traditional insurers like AllState (ALL 3.80%), which covers about 16 million customers with over 175 million policies. Lemonade's growth in customers and premium per customer both decelerated in 2021:

Source: Lemonade. YOY = Year-over-year.

Lemonade ended its third quarter with an unimpressive annual dollar retention (ADR) rate of 82%, which improved from 76% a year ago but still indicates nearly a fifth of its customers aren't sticking around.

Those messy numbers indicate Lemonade isn't as disruptive as it claims to be, and that it doesn't have much of a moat against larger insurers, most of which have been upgrading their apps with new AI services and can easily afford to offer better prices than Lemonade.

At the same time, Lemonade's gross loss ratio has consistently remained above its 2020 levels throughout the first three quarters of 2021:

Source: Lemonade.

Its big spike in the first quarter, which was mainly caused by the winter storm in Texas, also revealed just how easily climate change could disrupt its core homeowners insurance business.

In an effort to stabilize its gross margins, Lemonade rolled out "proportional reinsurance agreements" in the third quarter of 2020. Under that new business arrangement, Lemonade ceded 75% of its premiums to reinsurers in exchange for a 25% "ceding commission" for every ceded dollar. This move reduced its total revenue, its cost of revenue, and capital requirements.

As a result, Lemonade's revenue growth decelerated in 2021, but its adjusted gross margins expanded. Unfortunately, its operating expenses still soared and its net losses continued to widen:

Source: Lemonade.

To make matters worse, Lemonade is continually issuing more shares to subsidize its salaries and its all-stock takeover of Metromile -- which is also deeply unprofitable. As a result, its number of weighted average common shares have risen 136% year-over-year in the first nine months of 2021.

That toxic combination of slowing growth, widening losses, and ongoing dilution make Lemonade a tough stock to own as interest rates rise. The stock also still isn't a bargain at 14 times this year's sales.

What the bulls will tell you about Lemonade

The bulls claim Lemonade's popularity among younger and first-time insurance buyers, its robust growth in gross earned premiums, and its expanding portfolio of services indicate it still has room to grow.

At the time of its IPO, Lemonade claimed that approximately 70% of its customers were under the age of 35, which indicates its simplified, mobile-first approach resonates with Millennials. Its in force premium and gross earned premium also continue to rise at impressive rates -- even if it's now ceding most of those premiums to reinsurers under its new model:

Source: Lemonade.

The bulls will also claim Lemonade has two paths toward exponential growth. First, it could continue to disrupt traditional insurers and gain tens of millions of new users over the next few years.

Second, its takeover of Metromile, which sets the foundations for its new auto insurance business, will enable it to generate much higher premiums per customer over the long run, since auto insurance policies cost significantly more than homeowners, renters, life, and pet insurance policies.

If those two tailwinds kick in, Lemonade's revenue growth could accelerate again, economies of scale could kick in, and its losses would narrow.

Which argument makes more sense?

I recently sold my shares of Lemonade along with several other speculative growth stocks as I readjusted my portfolio to deal with higher interest rates. Lemonade is still an interesting company to follow, but I believe the bearish case will make a lot more sense than the bullish one for the foreseeable future.