Is Lemonade Stock a Buy Before Oct. 31?

Lemonade (NYSE: LMND) has disappointed investors in a big way over its four years of being a public company. It's down 73% since its first-day closing price, failing to meet expectations for profitability. However, if you'd bought at the right time, you would already have benefited from owning it -- it's up 67% over the past year.

There are all sorts of factors that impact how the stock moves in the short term, and one of the major ones is earnings. Lemonade is releasing third-quarter earnings on Thursday, Oct. 31. Depending on the results, Lemonade could move up or down, and it could be significant. Should you buy before the earnings release?

What Lemonade is all about

Lemonade operates an insurance company built on a digital substrate and informed by artificial intelligence (AI) and machine learning. That's a mouthful, and it really just means that the company is leveraging AI technology to do insurance in a better way.

Is it working? The verdict isn't out yet, but there are reasons to be confident. Lemonade was built in a different way than legacy insurers, with an interconnected system that speeds up information gathering and underwriting processes.

How that plays out from the consumer-facing side is that instead of a laborious process dealing with an agent, Lemonade onboards customers and pays out claims through chatbots. On the business side, Lemonade algorithms work through machine learning to keep improving organically and come up with precise policy rates.

The concept is attracting customers. It has more than 2 million customers as of the end of the second quarter and its in-force premium was up 22% year over year.

What's less impressive is Lemonade's loss ratio and its net losses. The loss ratio measures how much of a policy it pays out in claims, and that should go down as the algorithms improve. It hasn't been a linear process, and each quarter, the loss ratio is what investors are watching.

Image source: Lemonade.

The loss ratio improved by 15 percentage points year over year in the second quarter, the best improvement over the past three years.

The other pain point for investors is the net loss. Management said it's past its peak losses, but it's still high at $57 million in the second quarter.

However, management envisions that as it scales, its reliance on technology instead of headcount will lead to profitability. Its revenue is still a fraction of the big insurers, but as it grows, the technological advantage should kick in and give it a major edge over the competition.

What could happen on Thursday?

Growth has been strong in every way, from revenue to gross earned premium to premium per customer. So let's focus on what the market going to be looking at this week, the loss ratio and profit metrics.

Lemonade doesn't provide guidance for the loss ratio, but based on the chart above, you can see that it was 83% in the third quarter last year and was better for the past three quarters. If it remains under 80%, which would be at least four percentage points better year over year, the market should be happy.

As for profitability, that still has a ways to go. Management is guiding for about $57 million in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) loss, which is worse than $40 million last year. Wall Street is expecting loss per share of $1.03, and often the hits and misses here dictate how the stock reacts to the earnings release.

Not all stocks are highly impacted by earnings reports, but take a look at how Lemonade stock has fared after recent earnings reports:

LMND data by YCharts

Although It had a significant short-term reaction every time, it corrected pretty quickly to get back in line every time except the 2023 third quarter. It shot up and has stayed there, accounting for most of its gain over the past year. You can see how the stock rose each time in anticipation of good news and then fell. That's already happening in anticipation of this week's results, but not as much as last quarter.

That puts investors in a good position. If the results are weak, the stock will drop, but it won't be a disaster like it was in July. If they're well received, the stock could seriously soar and stay there until the next round of good news.

The odds are in your favor, both short-term and long-term. Short term, because the gain on good news is likely to be stronger than a drop on bad news. In the long term, Lemonade has a disruptive business that has broken through the barriers of entry that legacy insurers have held up with their immense strongholds. It has a bright future should its algorithms begin to outperform traditional insurance companies. There's no guarantee that will happen, and this is a stock for investors with an appetite for risk.

Investors should be focused on the long term, but if Lemonade stock soars after earnings, it could now be an excellent entry point.

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Jennifer Saibil has positions in Lemonade. The Motley Fool has positions in and recommends Lemonade. The Motley Fool has a disclosure policy.