There's more to Root for! (incl. Excel Workbook)
Explosive growth, courageous management, proven technology, unambitious valuation.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
Last week, I wrote about the distinction between ROOT 0.00%↑ and LMND 0.00%↑ based on their recent earnings reports.
While I had looked at Lemonade before, it was the first time for me to look at Root. And I must admit, over the past week whether I was going for a run, taking a shower or trying to fall asleep at night, that thing has not left me alone for one waking minute. It seems to be such a fascinating opportunity. So please bear with me for an addendum to my article from last week. Additional points must be made with respect to their operating performance and their valuation.
TLDR Summary
Root’s stock price is up 350% since their earnings two weeks ago, which feels insane at first glance. But as absurd as it sounds, it has merely reacted to an extraordinary earnings beat that only happens rarely at such a magnitude. This digesting process is not yet completed, which is why the stock keeps ripping. Friendly macro circumstances admittedly helped quite a bit. As long as these won’t turn overly sour, this stock has much more room to run in my opinion.
The company has not just demonstrated explosive topline growth. They have also shown credible progress to profitability and they have shown that their technology works. When I took a closer look, I particularly liked how they have reduced their reinsurance activity drastically from about 50% to about 20% of their written premiums. This demonstrates management’s confidence in their ability to underwrite risk skillfully. Such a move is even more remarkable considering the company’s current growth rate. After all, as a loss making company, they have balance sheet constraints to consider. Self-funded growth has limits and they depend on the mercy of Mr. Market to tap into external funding sources eventually.
Root’s 3Q23 and 4Q23 performance makes it clear that they have built a powerful insurance distribution and pricing platform that promises capital returns far in excess of a required rate. The consequence of this is obvious: They need a capital raise to fully leverage this opportunity. The bigger the better. A fully loaded and profitable P&C business usually trades at 3-4x tangible book value. If they raised $100m at $40 and funneled this capital successfully into policy underwriting, it could easily create $200-300m in value. We are talking about an economic value of about $15-$20 per share simply from raising capital. For a stock that traded at just $8 two weeks ago.
But even without this capital increase synergy, I see more upside. Before investors capitulated in droves on the company a year ago, they were trading at about 3x EV/revenues, which is in fact by and large in line with established carriers. These carriers are profitable, but they also grow at a much slower pace. If investors decided to grant Root with such a valuation again, it would trade at $85 based on their 4Q23 revenues. In a year from now, they may be at 20% organically higher revenues, which could value the company at $100. If they managed to smartly raise capital, say $150m at $50/share, the share price could be $120. I have added some sensitivity tables in the valuation section of this article. If you want to play with the numbers yourself, I also attached an excerpt from my workbook.