Artificial intelligence (AI) exploded in popularity in 2023, after a new version of OpenAI's ChatGPT application put the technology's capabilities on full display. AI has created an incredible amount of value for investors since then with Nvidia alone adding a staggering $2.9 trillion to its market capitalization.
But some companies were developing AI long before it captivated Wall Street, and Lemonade (LMND -10.78%) is one of them. Founded in 2015, it's an insurance technology company that uses AI chatbots to serve customers, and AI models to price policy premiums and manage its operations.
Lemonade reported its financial results for the third quarter last week, and its stock has since soared 33%. However, it's still down 85% from its all-time high, so here's why now might be a great time to buy.
Image source: Getty Images.
Accelerating growth in a key metric
Lemonade serves 2.3 million customers across its five products: renters insurance, homeowners insurance, life insurance, pet insurance, and car insurance. The company is successfully attracting younger age cohorts that have historically been underinsured, thanks to its technology-driven approach and its "Giveback" program, which donates a percentage of premiums to social causes.
Potential Lemonade customers will first interact with the Maya chatbot on its website, which is capable of writing quotes in under 90 seconds. Then, when it's time to make a claim, AI Jim typically pays them out in less than three minutes without human intervention. This is a significant upgrade to the customer experience compared to other insurance companies, which often use slow, human-driven processes.
Lemonade ended Q3 with record in-force premium (the value of premiums from all active policies) of $889 million, a 24% increase from the year-ago period. That marked an acceleration from the second quarter, when in-force premium grew 22% year over year. The company also shrank its employee headcount by 7% during Q3 because it's relying more heavily on AI to calculate premiums and automate business processes.
Lemonade's lifetime value (LTV) models are designed to predict the likelihood of a customer making a claim, switching insurers, and even buying multiple policies, in order to price their premiums. The LTV models grow more accurate with each new version, which leads to potential cost savings for the customer because they are charged fairer premiums.
But Lemonade's internal AI models can also identify underperforming and overperforming products and geographic markets, so managers can rapidly pivot the company's marketing spending to maximize revenue.
Significant progress when it comes to profitability
Lemonade's gross loss ratio (the percentage of premiums it pays out as claims) fell to 73% during Q3, which was the lowest level in four years. It's now within the range of Lemonade's long-term target, and that has positive implications for the company's ability to generate profits.
Its accelerating in-force premium growth, combined with its falling gross loss ratio and shrinking headcount, resulted in $37.5 million in gross profit during Q3, up a whopping 71% from the year-ago period.
Lemonade still lost $67.7 million at the bottom line on a generally accepted accounting principles (GAAP) basis. However, GAAP accounting requires the company to include one-off and non-cash expenses like stock-based compensation in its net income or net loss calculation, which isn't necessarily the best reflection of how much actual cash the business is generating.
That's why Lemonade's preferred measure of profitability is net cash flow, which is a non-GAAP (adjusted) metric that simply measures the change in the company's cash position. During Q3, Lemonade's net cash flow came in at $48 million, which was a record high and a 1,500% increase from the year-ago period.
Why Lemonade stock is a buy now
The consistent downward trend in Lemonade's gross loss ratio and its rapidly growing net cash flow are positive signs the company can scale without requiring further capital from financing or from an equity raise. That's good news for investors because raising more money often results in dilution, which can negatively impact returns.
That said, Lemonade is still a young company. It currently operates in the United States, the United Kingdom, and four European countries, but it wants to expand across Europe and other regions in the future. That could result in temporary increases in its gross loss ratio until it achieves scale in those new markets. But having a larger business is good news for investors over the long term.
As of this writing, Lemonade stock is down 85% from its all-time high, which was set during the tech frenzy in 2021. It was unquestionably overvalued back then with its price-to-sales (P/S) ratio soaring above 100, but it currently trades at just 3.6, which is near the cheapest level since the company went public in 2020.
It's also an 81% discount to Lemonade's average P/S ratio of 19.7:
Data by YCharts.
With a market capitalization of just $1.7 billion and significant momentum across its business, Lemonade stock could be a great buy for long-term investors.
