Insurance is an age-old industry that can be a double-edged sword. On the one hand, long-established incumbents dominate it, making it hard for new competitors to gain footing. But on the other hand, these incumbents can grow stale, inviting a disruptor to come along and make waves.

Up-and-coming insurance company Lemonade (LMND -10.78%) is trying to disrupt insurance by putting its spin on the industry. It's a small company worth just $2.2 billion today, leaving room for life-changing investment returns if it can successfully carve out its niche -- or even better, change the game altogether.

So, is Lemonade stock a millionaire maker? Or is the company likely to grow sour at some point instead?

Here is what you need to know.

Innovation is the growth path

Incumbent insurance companies are worth billions of dollars, including Allstate ($52 billion) and Progressive ($150 billion). These companies and Lemonade compete in property and casualty (P&C) insurance, which totaled over $850 billion in written premiums in 2022 -- just in the U.S. alone! Lemonade is worth just over $2 billion and has less than $900 million of in-force premiums, so it's still a nascent competitor in this field.

Lemonade has steadily expanded its insurance offerings over time to include get renters, homeowners, car, pet, and life insurance. Lemonade has 2.3 million total customers as of Q3, a 17% increase from a year ago. That's much faster growth than the population, which means Lemonade is winning business from industry incumbents.

How? Traditional insurance companies depend on vast networks of agents to sell policies, process claims, and generally deal with policyholders. Lemonade bucked that tradition, instead going to AI chatbots and a digital experience via its smartphone app. Lemonade claims you can receive payment for a claim in as little as three minutes. Lemonade's app has a 4.9 (out of five) star rating on Apple's iOS App Store.

Time will tell whether Lemonade's model continues to work. Incumbent competitors may eventually adapt to (or copy) Lemonade. Unfortunately, competitive moats are slowly dug over time. For now, Lemonade is winning and growing.

Is Lemonade's lack of profits a problem?

The biggest knock on Lemonade is that the business is losing money. Its net losses were $68 million in Q3, though the company did generate $48 million in net cash flow.

Here's the thing. Lemonade currently uses reinsurance to help protect itself from catastrophic losses. Essentially, reinsurance means Lemonade is taking out insurance on the policies it sells. It's like a safety net in case things go wrong. Lemonade is doing this because it's still a young insurance company accumulating the data it needs to analyze risk and price its insurance policies better. Its gross loss ratio, which measures premiums (incoming dollars) versus claims (outgoing dollars), has improved from 92% to 77% in just two years.

With the reinsurance reducing Lemonade's policy underwriting risks, it can focus more on growing its business and acquiring new customers. The downside is that Lemonade must cede a portion of its premiums to the reinsurer, which means the company is making less money per policy.

Ideally, once it's ready, Lemonade will shoulder more of that policy risk and profit more. That also doesn't rule out Lemonade eventually turning profitable despite using reinsurance. For now, the business is well funded with $979 million in cash and short-term investments, almost half its current market cap. Therefore, investors shouldn't necessarily see Lemonade's losses as a red flag.

So, is Lemonade stock a millionaire maker?

Lemonade is still a relatively tiny player in a massive industry. So, can it be a millionaire-making stock? Yes.

Whether it happens depends on a few things:

  • Lemonade continues to grow its customer base and take market share from incumbent insurers.
  • The company's loss ratios continually improve over time.
  • Lemonade eventually shows it can turn a profit.

The sky is the limit if these three things happen.

That said, the market has aggressively piled into speculative stocks such as Lemonade, which has risen over 80% in the past month. Yet, the stock is still down about 80% from its 2021 high. Today, Lemonade trades at a price-to-book value ratio of just under 4, sandwiched between the valuations of its incumbent competitors, Allstate and Progressive.

I'd argue the stock's valuation is probably about where it should be. Its faster growth is somewhat offset by its lack of profits. Investors who want to own Lemonade should consider buying shares slowly. The stock has proven very volatile, so dramatic price swings are bound to occur.