LMND

These 2 Growth Stocks Are Rapidly Approaching Profitability: Here's Why You Might Want to Buy Before They Do

It wasn't too long ago that it was fully acceptable, and maybe even expected, for unprofitable growth stocks to command high valuations as long as they were growing. With access to as much cheap capital as needed, there wasn't much of a need to focus on efficiency.

That's changed over the past couple of years as interest rates have risen and investor appetite for speculation has dwindled. So, we saw many growth companies pivot their focus to creating a sustainable path to profitability, and many succeeded.

However, there were some companies for which profitability seemed many years away, if it would ever happen. Two of those are insurance disruptor Lemonade (NYSE: LMND) and neighborhood social media platform Nextdoor (NYSE: KIND). But now it looks like both could achieve profitability far sooner than even their management teams had expected.

Lemonade's numbers are moving in the right direction

Insurance disruptor Lemonade has been growing rapidly since its IPO a few years ago, but it hasn't really shown investors much of a path to profitability and sustainability. That might be changing.

First, the growth numbers. Lemonade now has 2.1 million customers, and its in-force premium has grown by 89% over the past two years. Gross earned premium grew by 22% in the first quarter of 2024, and the company's retention rate of 88% shows a 100-basis-point improvement.

However, the real story is profitability. Lemonade's loss ratio, the percentage of collected premiums used to pay claims, has decreased by eight full percentage points compared with the first quarter of 2023 and at 79% is approaching management's 75% target. Lemonade's adjusted EBITDA loss has narrowed from $51 million to $34 million year over year, and management now expects to be cash flow breakeven by the end of this year, with positive net cash flow expected in 2025. With $927 million of cash and investments in the bank, Lemonade has plenty of financial flexibility, and if the company actually starts adding to its cash position over time (as opposed to burning through cash like it has been doing), it would be a big win.

Nextdoor's founder is back, and the early results are strong

Nextdoor was another company in a growth-at-all-costs mentality, and the company's former leadership stuck with that plan for a little too long, even after growth slowed dramatically. But Nextdoor's founder Nirav Tolia recently stepped back into the CEO role and is committed to responsible capital allocation and running an efficient business.

In his first shareholder letter since returning as CEO, Tolia discussed the "founder's mentality," saying that it was an important quality for founders to always act like owners. As he went on to say, "Owners treat every dollar like it is their last. ... We expect to pair a disciplined approach to capital allocation with a continued focus on achieving our financial commitments."

The latest growth numbers aren't anything to get terribly excited about. Nextdoor's weekly active user (WAU) base grew 2% year-over-year, while average revenue per WAU grew by 4%. But the big difference is that the company's adjusted EBITDA loss narrowed by 36% and margins are clearly heading in the right direction.

Most importantly, Nextdoor now expects to be free cash flow positive by the fourth quarter of 2024, a full year sooner than the previous expectation.

Don't read too much into the recent growth numbers. Tolia has only been back in the role for a short while and aims to improve Nextdoor's advertising capabilities and drive user engagement and WAU growth. Improved self-service ad capabilities were the primary growth driver in the first quarter, session depth -- a measure of how deeply engaged users are -- improved by 36% year-over-year, and recent advertiser results have been strong.

These businesses are trading for shockingly low valuations

One interesting fact about both Lemonade and Nextdoor is that they have a lot of cash, and the market isn't valuing their businesses very highly.

  • Lemonade has $927 million in cash and investments, no long-term debt, and a market cap of just under $1.2 billion, indicating that the market is valuing the business itself at about $273 million.
  • Similarly, Nextdoor has $498 million in cash and short-term investments, no debt whatsoever, and has a $924 million market cap, even after a post-earnings rally. This implies the business itself is worth just $426 million.

There's still a lot that needs to go well for either of these companies to actually achieve their profitability targets. But it's clear that both are taking efficiency seriously, and with big opportunities, great balance sheets, and low valuations, it could be a good time to take a closer look.

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Matt Frankel has positions in Lemonade and Nextdoor. The Motley Fool has positions in and recommends Lemonade and Nextdoor. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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