The majority of your portfolio’s earnings will likely come from a minority of the stocks you own.
Lemonade is trying to transform the insurance industry with big data and artificial intelligence.
The Pareto Principle (also known as the 80:20 rule) states that 20% of the stocks in a portfolio generate 80% of the returns. That makes sense. The worst case scenario after buying a stock can be a 100% loss, but the sky is the limit. Given enough time, a stock can increase in value by 10x, 50x, or even 100x. That is one of the reasons why a long-term perspective is so important.
With that in mind, I think Lemonade (NASDAQ:GOLF, 12.65%) could deliver 100x returns over the next 15-20 years. Recent quarters have been difficult for the company, as high inflation and possible interest rate hikes have compounded the impact of disappointing financial results. That’s why Lemonade stock is down 85% from its peak. But with investor sentiment taking a hit, now might be a good time to buy some stocks.
You should know that.
A disruptive business model
Lemonade is an insurance company that relies on artificial intelligence to make its business more efficient and customer friendly. The digital platform does away with representatives and paperwork, for example. Instead, customers interact with intelligent chatbots to shop for insurance and file claims, helping Lemonade keep staffing costs down. In fact, management believes that the cost of acquiring clients is 10 times less than that of a traditional insurance company.
Even better, Lemonade’s digital platform is designed to capture a volume and variety of data that traditional systems can’t match. The company collects about 100 times more data per customer, which should (eventually) allow Lemonade to quantify risk more accurately, meaning its claims ratio (i.e. claims paid as a percentage of premiums) should be below the industry average. By paying fewer claims (and spending less on wages and salaries), the company should be able to undercut its peers.
A disappointing performance
Unfortunately, Lemonade posted a 90% loss rate over the past year, which compares poorly to the industry average of around 70% in the first half of 2021. However, in 2020, the company posted a 71% loss. Management attributes the recent increase to strong growth in newer product offerings, such as homeowners and pet insurance, which have higher claim rates than the company’s more mature rental business.
However, losses in homeowners and pet insurance are declining, with management expecting all lines to see claim rates below 75%. This news should be encouraging for shareholders.
The focus on providing a seamless user experience has helped Lemonade attract 1.4 million customers in 2021, up 43% from the previous year. And the average customer spent 25% more as more people bought additional policies (like pet insurance) or switched to more expensive insurance (like renters insurance to home insurance).
Gross profit increased 26% to $31.2 million, although Lemonade remains unprofitable under GAAP and the company generated $154 million in negative free cash flow last year.
A chance of a 100x return
Looking ahead, Lemonade’s recently launched auto insurance product could be a key growth driver, bringing the target market to over $400 billion in the US alone. More importantly, Lemonade’s current clientele The company already spends $1 billion a year on auto insurance, which means the cross-selling opportunities are significant.
To accelerate its entry into this space, Lemonade plans to acquire AI-powered auto insurance provider Metromile for $500 million in stock. Once this step is complete, Lemonade will be able to integrate Metromile’s own travel data into its own AI models.
Lemonade is a small-cap company with a huge market opportunity and a differentiated business model. The stock currently has a price-to-book ratio of 1.1, making it cheaper than peers like Allstate and progressive, which trade at 1.5 times or 3.5 times book value. If Lemonade can continue to attract customers, increase sales and reduce claims at the same time, this innovative company, now worth just over a billion dollars, could grow 100-fold in the next 15 to 20 years in value.
The item Would you like a 100-x refund? 1 small-cap stock to buy now and hold long was first featured in The Motley Fool Germany.
This article represents the author’s opinion, which may differ from the “official” recommendation position of a premium Motley Fool advisory service. Questioning an investment thesis, even one of your own, helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
This article was written by Trevor Jennewine and was published on Fool.com on 03/16/2022. It has been translated so that our German readers can join the discussion.
Trevor Jennewine owns Lemonade, Inc. The Motley Fool owns stock and recommends Lemonade, Inc. The Motley Fool recommends Progressive.
Motley Fool Germany 2022