When applied to investing, the Pareto principle (also known as the 80-20 rule) suggests that 20% of stocks in a portfolio generate 80% of returns. Makes sense. After buying a stock, the worst outcome is a 100% loss, but there is no upper limit. Given enough time, a stock could multiply by ten, 50 or even 100 times its value. This is one of the reasons why a long-term perspective is so important.
With this in mind, I think Lemonade (LMND 8.61% ) could generate 100x returns over the next 15-20 years. The past few quarters have been difficult for the company, as high inflation and potential interest rate hikes have compounded the fallout from a somewhat disappointing financial performance. Because of this, the lemonade stock has fallen 85% from its peak. But with investor sentiment swirling around the drain, now could be a good time to buy some stocks.
Here’s what you need to know.
A disruptive business model
Lemonade is an insurance company that relies on artificial intelligence to make its business more efficient and user-friendly. For example, its digital-first platform cuts out agents and paperwork. Instead, consumers interact with smart chatbots to purchase insurance and file claims, which lowers Lemonade’s payroll costs. In fact, management estimates that their customer acquisition costs are ten times lower than those of a traditional insurance company.
Best of all, Lemonade’s digital platform is designed to capture a volume and variety of data that legacy systems can’t match. The company collects around 100 times more data points per customer, which should (eventually) allow Lemonade to quantify risk more precisely, meaning that its loss ratio (i.e. loss payments as a percentage of premiums) is expected to be lower than the industry average. In turn, by paying fewer claims (and spending less on payroll), the company should be able to undercut its competitors on price.
A disappointing financial performance
Unfortunately, Lemonade posted a loss ratio of 90% last year, which compares poorly to the industry average of around 70% in the first half of 2021. However, the company posted a loss ratio of 71% in 2020, and management attributes the recent to strong growth in new product offerings – like homeowners and pet insurance – which have a higher loss ratio than larger tenant insurance businesses. mature in society.
However, losses in the home and pet insurance verticals are declining, and management expects all lines of business to eventually achieve a loss ratio below 75%. Shareholders should be encouraged by this news.
Additionally, Lemonade’s focus on a frictionless user experience helped it reach 1.4 million customers in 2021, up 43% from the previous year. And the average customer spent 25% more, as more people added additional policies (eg, pet insurance) or upgraded to more expensive coverage (eg, upgraded coverage). tenants to landlord coverage).
To that end, gross profit rose 26% to $31.2 million, although Lemonade remains unprofitable on a GAAP basis, and the company generated negative free cash flow of $154 million during of the past year.
A chance for 100x returns
Going forward, Lemonade’s recently launched auto insurance product could be a big catalyst as it takes its potential market to over $400 billion in the United States alone. More importantly, the company’s current customer base already spends $1 billion on auto insurance each year, which means the cross-selling opportunity is significant.
To accelerate its entry into the space, Lemonade plans to acquire AI-powered auto insurance provider Metromile for $500 million in stock. When complete, this move would allow Lemonade to integrate Metromile’s proprietary driving data into its own AI models.
Here’s the big picture: Lemonade is a small-cap company with a big market opportunity and a differentiated business model. Currently, the stock has a price-to-book ratio of 1.1, meaning it’s cheaper than competitors like Allstate and progressive, which trade at 1.5 times book value and 3.5 times book value, respectively. But if Lemonade can continue to win customers and grow its revenue while reducing its loss ratio, I think this disruptive business — currently worth just over $1 billion — could grow its business 100-fold. value over the next 15 to 20 years. years.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice 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.