As the investing world heads into earnings season -- where all public companies are required to report their financial figures -- the process of monitoring the success of every single stock you own can be laborious. Over 500 companies are reporting their latest quarterly earnings this week alone, which could leave some investors with analysis paralysis.
An easy solution to counteracting this is to focus on a few stocks extremely closely. Investors can pick a few companies out of their portfolio that have an extra important quarter this month and focus very hard on those few stocks. This is what I do as an investor, and this quarter will be very important for two artificial intelligence companies. Here's why I will be watching Lemonade (LMND 1.79%) and Riskified (RSKD -0.16%).
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1. Lemonade: The AI insurer
Lemonade is known for bringing artificial intelligence to the forefront of the insurance space. The company enables AI to make decisions about applications and claim payouts in minutes. Lemonade also has structured its incentive systems to align with its customers, unlike most insurance platforms. The company takes a portion of the premium up front as revenue, and if there are any premiums left over after all the claims are paid out, they go to charity. This gets rid of the incentive that most insurance companies have to deny as many claims as possible to earn more revenue.
As a result, Lemonade has been one of the most well-liked insurance companies and is seeing rapid adoption. It took the company just 4.25 years to reach 1 million customers, whereas it took other major companies like State Farm 22 years to do so. Now, the company is already on its way to doubling this figure -- in Q3 2021, the company had over 1.3 million customers.
However, the company is not as strong on the financial front. Lemonade's loss ratio -- the percentage of premiums paid out in claims -- reached 77% in Q3 compared to 72% in the year-ago quarter. This means that even though Lemonade's premiums collected grew 84% year over year to $347 million, its claims grew more than that. This high loss ratio resulted in major net losses: The company lost $66 million in Q3, which represented 186% of revenue over the same period.
While this news was not great, there were some silver linings. The company noted that most of its poor loss ratio came from younger products like pet insurance. These newer products have younger AI engines and fewer data points to learn from, but as it obtains more data, it will become more accurate.
In Q3, the company noted it did see improvements. Lemonade's pet loss ratio improved by four percentage points sequentially, while its homeowners loss ratio improved by 52 percentage points year over year.
The company has not released an earnings date yet, but this report could be key. If the company can improve its loss ratio, it will also result in improvements in its profitability and gross profit. Lemonade shares have had a bumpy ride -- falling 80% over the past year -- but if the company can continue making loss ratio improvements, shares could turn around.
2. Riskified: A test for its fraud detection platform
Riskified is another stock in hot water, with a pivotal earnings report coming up. The company uses AI to detect fraud for e-commerce companies that cannot do it in-house. Riskified uses its engine to discover fraudulent e-commerce transactions and deny them on behalf of the company, and its services have been very valuable to its customers. Riskified only had 2% customer churn in 2020, and in the most recent quarter, its gross merchandise volume (GMV) under management neared $21 billion.
Riskified has another appealing aspect to its business: its Chargeback Guarantee. If its AI engine accepts a fraudulent order, Riskified will cover the cost of the lost goods for its customer. While this makes Riskified an amazing product for e-commerce companies, it can hurt Riskified if its AI goes awry. Its gross margin is made primarily by how much it pays out in Chargebacks to its customers, and if its margins shrink, that means its AI was often wrong and paid out more in chargebacks.
In Q3 2021, that is exactly what happened. Riskified's gross margin declined from 53% in the year-ago quarter to 46%. Going into the fourth quarter -- which it reports on Feb. 23 -- it will be crucial to see if its margin can improve. Management cited newer markets as the cause for the drop in gross margin, rather than unfixable AI deficiencies, which will improve over time as its engine collects more data in the space.
Riskified trades at 4.7 times sales, and considering the company is roughly free cash flow breakeven and has $444 million on the balance sheet, it also trades at 3 times cash -- both of which are extremely low multiples. The company is unprofitable -- it lost $150 million in the first nine months of 2021 -- so this cash balance will shrink over time if the company cannot begin generating cash. However, if the company can improve its margins in this quarter and the coming ones to increase its free cash flow, Riskified could be trading at a major bargain right now.
