Not long ago, it was commonplace, even anticipated, for unprofitable growth stocks to carry high valuations solely based on their growth trajectory. With easy access to inexpensive capital, efficiency wasn’t a top priority.
However, this trend has shifted in recent years, with rising interest rates and a waning investor appetite for speculation. Consequently, many growth-oriented companies redirected their focus towards establishing a sustainable path to profitability—and many succeeded.
Nevertheless, there remained companies for which profitability appeared distant, if achievable at all. Two such examples are insurance disruptor Lemonade (NYSE: LMND) and neighborhood social media platform Nextdoor (NYSE: KIND). However, recent developments suggest that both companies could reach profitability much sooner than anticipated, even by their own management teams.
Lemonade’s numbers are moving in the right direction
Since its IPO a few years ago, Lemonade, the disruptive insurance company, has demonstrated rapid growth, albeit without a clear path to profitability and sustainability—until now.
Let’s delve into the growth metrics first. Lemonade boasts 2.1 million customers, with its in-force premium surging by 89% over the past two years. In the first quarter of 2024 alone, gross earned premium expanded by 22%, while the company’s retention rate of 88% reflects a noteworthy 100-basis-point improvement.
However, the real narrative lies in profitability. Lemonade’s loss ratio, a crucial metric indicating the percentage of collected premiums used to pay claims, has decreased by a significant eight full percentage points compared to the first quarter of 2023, nearing management’s 75% target at 79%. Moreover, Lemonade’s adjusted EBITDA loss has narrowed from $51 million to $34 million year over year. Encouragingly, management anticipates achieving cash flow breakeven by the end of this year, with positive net cash flow projected for 2025. Bolstering its financial position is Lemonade’s substantial $927 million cash and investments in reserve, affording ample financial flexibility. Should the company start accumulating cash over time, rather than depleting it as previously, it would mark a significant milestone.
Nextdoor’s founder is back, and the early results are strong
Nextdoor, previously entrenched in a growth-at-all-costs approach, faced a prolonged period of slowing growth under its former leadership. However, with founder Nirav Tolia’s return to the CEO role, the company is now prioritizing responsible capital allocation and operational efficiency.
In his recent shareholder letter, Tolia emphasized the importance of the “founder’s mentality,” highlighting the need for founders to act as true owners, treating every dollar with utmost care. The company is committed to disciplined capital allocation while maintaining focus on meeting financial commitments.
While the latest growth metrics may not be particularly exhilarating, with Nextdoor’s weekly active user (WAU) base growing by a modest 2% year-over-year and average revenue per WAU increasing by 4%, the significant improvement lies in the narrowed adjusted EBITDA loss, down by 36%, signaling a positive shift in margins.
Of paramount importance is Nextdoor’s revised expectation to achieve free cash flow positivity by the fourth quarter of 2024, a full year ahead of previous projections.
Although recent growth numbers may not reflect substantial changes, Tolia’s tenure as CEO has just begun, and his strategic focus on enhancing advertising capabilities and driving user engagement and WAU growth is underway. Initial strides have been made, with improved self-service ad capabilities driving growth in the first quarter, accompanied by a notable 36% year-over-year increase in session depth—a measure of user engagement. Additionally, recent advertiser performance has been encouraging.
These businesses are trading for shockingly low valuations
These companies are currently trading at remarkably low valuations.
Consider Lemonade, which holds $927 million in cash and investments, carries no long-term debt, yet boasts a market capitalization of just under $1.2 billion. This suggests that the market is attributing a value of approximately $273 million to the core business itself.
Similarly, Nextdoor possesses $498 million in cash and short-term investments, carries no debt, and despite a post-earnings rally, maintains a market capitalization of $924 million. Even after the rally, the business itself is estimated to be valued at only $426 million.
While both Lemonade and Nextdoor face challenges in achieving their profitability targets, their commitment to efficiency is evident. With substantial opportunities ahead, strong balance sheets, and undervalued positions, now might be an opportune moment to delve deeper into these companies.
