Is Root Stock a Buy?

Insurance technology company Root (NASDAQ:ROOT) has had a rocky couple of years, to say the least.

 

In 2021, the startup lost over half a billion dollars. In 2022, the stock is down over 60 percent and has lost nearly 90 percent of its value over the last 12 months.

 

With such a pronounced selloff, is it time to buy Root stock now?

 

Let’s investigate. 

 

Root is an app-based auto insurance provider that focuses on streamlining and automating the insurance application process.

 

Using Root, users can automatically apply for insurance policies directly from their smartphones by scanning their driver’s licenses. This streamlined approach makes Root much more consumer-friendly than many legacy insurance providers.

Root also uses a technology-driven risk assessment model. Rather than using standard insurance metrics like credit scores or employment, Root leverages users’ smartphone sensors to quantify their risk levels as drivers. This system rewards safe drivers with lower rates, even if they would normally be assessed as higher risks by traditional insurers.

 

While Root’s approach to applications and risk is innovative, the company operates much like any other insurer by assigning and collecting monthly premiums. This model provides the company with a recurring and predictable source of income similar to a subscription business.

 

Due to less aggressive spending on marketing, Root’s top-line written premiums declined 8 percent in Q1. This brought the figure down to $187 million for the quarter.

 

However, the gross earned premiums were up 9 percent, reaching $175 million. Operating losses were $71 million, down 25 percent from the same period in 2021. This translated to a loss of $0.30 per share, substantially better than the $0.42 loss analysts had expected.

 

Root is currently working to cut costs in its business as much as possible, which accounted for much of the improvement in operating losses.

 

The company’s technological approach to the insurance business has also allowed it to move quickly in a shifting rate environment.

 

Approximately 85 percent of Root’s rate change analysis is automated, allowing it to adjust its pricing more quickly than traditional insurance companies.

 

While Root’s ongoing losses are obviously concerning, the company faces an even bigger hurdle in the form of entrenched competition. Legacy insurers like Allstate, State Farm and Geico have huge moats around their businesses that will be difficult to overcome, even with Root’s self-service model and technology-driven approach.

 

It’s far from impossible for Root to break in, especially among younger users. As its slow growth shows, however, the process of carving out a user base in the auto insurance industry is anything but rapid.

 

From an investor perspective, Root also has to compete with rival insurance technology company Lemonade.

While its focus is more on home and renter’s insurance, Lemonade has begun moving into the auto insurance business. Lemonade is also growing much more quickly, increasing its gross earned premiums by 71 percent in Q1. Like Root, Lemonade has sold off aggressively this year, leaving both companies trading far below their 2021 highs.

 

As often happens with low-priced startup stocks, there’s a massive range of analyst price targets for Root stock. From its current price of $1.25, the median price target puts Root up 76 percent to $2.20 over the next 12 months. The low target of $1.50 and the high target of $6 would give it 20 percent and 380 percent upside, respectively.

 

In terms of value, Root’s metrics are at decent. The stock trades at a ratio of 0.89 to sales and 0.68 to book, suggesting at the very least that it isn’t overvalued.

 

Root also doesn’t carry excessive debt, with a debt-to-equity ratio of 0.62. All of these factors may help to offset the fact that Root is still losing a great deal of money and make it more attractive for investors.

Slow growth, competition and a reduction of marketing spending all work against Root’s promising technological thesis.

 

There’s little doubt that the company’s innovative approach to auto insurance produces good results and places a greater focus on driver safety than legacy insurance models. Root’s risks, however, are much more associated with its business than with the technology that powers it.

 

If Root cannot pare back losses while expanding its revenues, the stock could take a long time to take off. The company will also need to begin taking market share from its larger, more entrenched competitors in order to achieve more rapid growth.

 

Lemonade is in a slightly better position to do this, as it already has a built-in customer base from users who hold home or renter’s policies.

 

Root falls deeply into the category of high-risk, high-reward startup stocks. There’s no doubt that the company’s streamlined, customer-focused approach provides value to the consumer and allows good drivers to save money on their policies. The company is growing, and efforts to cut expenses have narrowed its losses somewhat. Neither one of these processes, however, is occurring as quickly as investors might ideally like.

 

Competition is almost certainly the biggest problem for Root. Insurers that have been doing business for decades have moats that even innovative technology will have trouble breaching. Root also has to compete with Lemonade for the share of the market that is actively looking for alternative insurance providers.

 

Under other circumstances, Root would look like a poor investment. However, the sheer cheapness of the stock goes a long way toward making up for these pitfalls. Root could be a decent value if it turns its business around. As analyst forecasts show, this stock could rise significantly over the next year. On a longer horizon, Root has at least the potential to provide investors with many times their initial investment in returns.

 

Overall, Root is a stock that only seems suitable for the most risk-tolerant investors. Even then, it is likely best to open only a small position, possibly balanced off with a similar position in Lemonade. For conservative investors, though, Root’s risks are probably too high. Investors who already hold Root should most likely hold, as there’s at least a decent chance that the stock will make up some of its losses in the next 12 months.

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