Even though it’s down 80%, I don’t sell lemonade

Lemonade (LMND -7.40% ) the stock went and did what I thought was impossible: slip below $30 per share and lose 80% of its value over the past year. Many investors are rushing off this growth stock which hasn’t done much growth but a lot of tanking.

I get fear. But I also think it’s unreasonable. I also wouldn’t want to lose my main when Lemonade has such potential. Here’s why I still trust the lemonade stock.

The fear is real

Shares of the online insurer took off when it went public in the summer of 2020. But enthusiasm quickly evaporated as losses piled up and the loss ratio rose. Both of these issues continue to plague the company. In the third quarter, net loss increased from $31 million in 2020 to $66 million in 2021. The loss ratio, or approximately the difference between premiums collected and claims paid, increased five points from a year on year to reach 77%. More so, investors were disappointed by Lemonade’s acquisition of the car insurance company MetroMilewhich resulted in more losses and higher loss ratios.

Image source: Getty Images.

Lemonade management was very excited about the announcement. It launched Lemonade Car auto insurance last year, and instead of waiting to enter various state-by-state markets, the MetroMile deal allowed it to enter those markets much faster. This should fill the top line and eventually spill over to the bottom line. So, even though it adds higher losses now, the company’s goal is to make a profit much faster.

So what are investors really worried about? Some start-ups grow too quickly, lose money, and end up closing because revenue doesn’t catch up. Platoon saw something like this because it moved very quickly to meet demand as people socially distanced, and now it may be in a cash crunch. Activist investors have called for a new chief executive, which the company has acted on, and to explore a sale, which it hasn’t, perhaps in hopes it will recover under new management and restructuring. This is the type of situation Lemonade investors want to avoid.

Why there is so much potential

On the other hand, much of what happens at Lemonade is positive. Premiums In Force (IFP), which is the company’s primary metric, is steadily increasing by around 90% year over year every quarter. This is due to a combination of two factors: the enrollment of new members and the increase in premiums per policy. The latter has seen impressive growth, rising 26% in the third quarter. This means that, overall, Lemonade customers are adding new types of insurance to their policies or purchasing more expensive policies.

Both of these bode well for Lemonade, whose strategy is to target a younger demographic and grow with them as their political needs grow. Her ideal clients are in their early thirties, buying their first home and their first car. Last year, Lemonade added pet insurance, term life insurance, and auto insurance to its tenant and homeowner policies to make it a reality. Customer numbers are also improving, and Lemonade ended the third quarter with nearly 1.4 million, a 45% year-over-year increase.

In other words, the strategy is working, and so far the company is growing its revenue at a rate that makes it very competitive despite its heavy losses.

As an AI-powered company, it is also constantly refining its model for greater pricing and pricing accuracy. This should lead to an improvement in the loss ratio and increase profitability.

I don’t plan to sell

My investment in Lemonade stock is down a bit. But I didn’t invest to see immediate gains. I find the business attractive and I am ready to wait and see it pay off. I am impressed with the company’s management and strategy and have confidence in the company’s long-term prognosis.

Lemonade reports fourth quarter results this week, and investors should look for improvements in loss ratio and continued growth in PFI, revenue and premium per customer.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

About Patrick K. Moon

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