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Saturday, September 18, 2021

Lemonade (LMND), a semantic analysis of earnings: time to buy?

or Why I am not investing in Lemonade - LMND (...yet)

Early in August Lemonade insurance company announced their earning and quarterly updates. The stock did not farewell, creating a potential buy opportunity. This was also discussed quite a bit on the various internet fora and there were many proponents of the stock as well as those who felt that perhaps it was not the right time. This piqued my interest in LMND since it is a finance-tech (fintech) insurance company. Lemonade Inc. offers a number of products including renters' insurance, homeowners' insurance, pet insurance and term life insurance in the United States. They also operate in limited areas of Europe such as Germany, the Netherlands, and France. They have a predominantly young demographic (approx 65-70%) and catchy ads to target to their target population. 

This encouraged me to dig deeper in to their earnings, operations and fundamentals with 'semantic network analysis'. You may perhaps know from my other articles on the site, I believe this method is unique in that it allows to seek hidden patterns or those connections that are not immediately revealed. 

The rationale for doing something like this is that ALL text has a linear structure (which is top-down, left to right etc) which  is the most common way of conveying information. However, in this linear flow, certain connections can be missed. Unsupervised Concept network analysis takes concepts in the text and breaks them into parts, which are then connected by common linkages. It is process intensive but is highly informational. This nonlinear text visualization of concept linkages allows for hidden patterns to be revealed, read between lines. 

With that brief intro, let me walk you through the process of my analysis of Lemonade's reports. The earnings came out on August 4th, 2021, right after this came out, I generated my unsupervised semantic network to analyze if it was a good opportunity to invest in LMND. This network model is shows in figure 1.

Figure 1: An unsupervised semantic text network analysis of Lemonade Co. earnings
Each node above, represents a tangible concept and entity and it is linked by edges (lines) which connect the related nodes.

  • Light blue nodes: pertain to discussion on Lemonade car, their car insurance product
  • Green nodes: pertain to their financial situation and their arrangement with reinsurance markets
  • Yellow nodes: are their existing products (home, pet etc)
  • Pink nodes: pertain to their progress and expansion plans
  • Purple nodes: pertain to their ESG efforts

Then using a computational algorithm (force-directed layout) to space them out, linked nodes are pulled closer while those that are not related are pushed apart. This is how patterns and connections emerge (figure 1).

FOUR broad themes emerge

1) Reinsurance drag: The is a big factor weighing down the business and that is the their necessary partnership with reinsurance industry. They are contracted to cede 75% of the premium they obtain from customers that obtain insurance through Lemonade. This is going to be a big drag until 2023, when they will renegotiate the terms of this contract. They are showing some improvement in reducing this percentage but it will continue to be a drag. Also there is 'new business penalty' which means as they expand into new lines of business, this penalty will tack on and eat into their profit margin. This was huge flag for me. A turnaround for me would be to see this at much lower percentage (ideally zero) to renegotiate after 2023 and see what terms are offered. Moreover, the location of this cluster of nodes right between Lemonade car (light blue) cluster and other products (yellow nodes), tell me of the profound impact this has on their operations.

2) Verticals need better performance and integration: Their products are mature and work HOWEVER, the performance across the board is lumpy. Some products (yellow nodes in graph) are floundering like life and renters while others are doing better (pet). A turnaround factor for me if, in next few quarters, we see company firing on all cylinders for ALL of their products.

3) Lemonade car still has to go live: there are significant goals that need to be met before their car insurance product is ready. It is revolutionary no doubt - where car insurance is going to based of telematics data and AI etc. So far they do not have regulatory approvals and did not provide launch dates. A turn around for me on this would be is a) they get regulatory approvals and b) they launch it.

4) The ESG nodes and the expansion nodes are sparse: This part of the network graph was anemic, at least as far as their discussion goes. I would like to see a much more robust patterning here.

The stock has fallen another 10-12% since and as of today the chart looks like this (figure 2, below)

Figure 2: Technical set up for traders (image courtesy: Stockcharts.com)

A technical view of the stock shows a divergence between stock price and RSI as well as MACD (image from www.stockcharts.com) which may suggest they a small price improvement is possible. This may be okay for stock traders who want to try and scalp some profits. However, the underlying fundamental story has not changed for me and so as a long term investor, I have NOT entered into a long position yet.

Conclusion: Based on my semantic analysis I decided to not invest in Lemonade and wait till there are improvements in certain key issues.