Should You Buy Lemonade Stock While It's Below Its IPO Price?

Lemonade (NYSE: LMND) , a provider of AI-powered online insurance services, went public at $29 per share four years ago. It soared to a record high of $183.26 during the apex of the meme stock rally in January 2021, but it now trades at about $22.

Lemonade's stock dropped below its IPO price as its growth slowed, it racked up persistent losses, and rising rates popped its bubbly valuation. Should contrarian investors buy this out-of-favor stock as a turnaround play?

Image source: Getty Images.

Why did investors sour on Lemonade?

Lemonade relies on AI chatbots to onboard its customers and settle claims. That streamlined approach made it an attractive option for younger first-time buyers, many of whom were baffled by the opaque and complicated process of buying traditional insurance plans. Approximately 70% of its customers were under the age of 35 at the time of its IPO.

Lemonade initially only sold homeowners and renters insurance, but it expanded into the term life, pet health, and auto insurance markets after its IPO. It acquired Metromile in 2022 to accelerate the expansion of its auto insurance business. Like many other insurers, Lemonade offered discounts for customers who bundled together its plans.

The bulls believed Lemonade would disrupt traditional insurers. But over the past three years, its growth in customers, in-force premiums (IFP), and gross earned premiums (GEP) all decelerated as its adjusted gross margins declined.

Data source: Lemonade.

That slowdown is worrisome because Lemonade only served 2.1 million customers in the first quarter of 2024. That makes it a tiny underdog compared to market leaders like Allstate (NYSE: ALL) , which serves more than 16 million customers, and State Farm, which handles over 85 million in-force policies.

So unless Lemonade can significantly scale its business, it could struggle to narrow its persistent losses. Lower interest rates could also force most insurers to invest in higher-risk and higher-yielding investments instead of stable fixed-income investments -- and that cyclical pressure could make it even tougher for Lemonade to break even.

For 2024, Lemonade expects its revenue to only rise 20% to $511 million-$515 million -- compared to its 67% growth in 2023 -- as it slightly narrows its adjusted earnings before interest, taxes, depreciation, and amortization ( EBITDA ) loss from $178 million in 2023 to a loss of $151 million-$155 million. Analysts expect it to narrow its net loss from $237 million in 2023 to $209 million in 2024 on a generally accepted accounting principles ( GAAP ) basis.

The case for a long-term turnaround

That situation seems grim, but investors shouldn't ignore the positive numbers. Its loss adjustment expense ratio fell sequentially for three consecutive quarters, and its annual dollar retention rate rose sequentially over the past two quarters.

Those stabilizing costs and retention rates suggest it can keep growing as it rolls out more insurance services and expands into more U.S. states and overseas markets. They could also silence the bearish notion that it's just another underdog insurer that is dressing up an old business model with fancy generative AI chatbots and algorithms.

Lemonade also claims it can achieve a break-even cash flow by the end of 2024, and that its cash flow will turn positive on a "consistent basis" starting in the first quarter of 2025. Achieving that goal would counter the common criticism that its business is unsustainable.

With an enterprise value of $1.3 billion, Lemonade's stock looks cheap at just 2.5 times this year's sales. Its insiders have also bought 20 times as many shares than they bought over the past 12 months, even though nearly 24% of its outstanding shares were still being shorted as of July 15. All of those factors could set it up for a big short squeeze.

Should you buy Lemonade at a discount to its IPO price?

Lemonade's downside might be limited, but it probably won't claw back above its IPO price until it stabilizes its customer growth and achieves a break-even cash flow. Even if it achieves those goals, it still needs to prove it can scale its business and narrow its net losses as its larger rivals roll out their own generative AI tools.

For now, investors should keep an eye on Lemonade -- but they shouldn't rush to buy its beaten-down stock. It takes economies of scale to survive in the insurance industry, and Lemonade still hasn't proven that it can keep pace with its competitors.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Lemonade. The Motley Fool has a disclosure policy .