Root Holdings (NASDAQ:ROOT) is the parent company of Root Insurance, an online auto insurance company that uses data from its customers’ smartphones to track driving habits and assign premiums based on perceived safety or risk.
The insurer has been growing quickly over the past year as more consumers seek out lower insurance premiums in what has become an extremely expensive market.
Is ROOT stock the next big thing, or has the tech-focused insurance startup already run up too much to be a good investment?
Root’s Rapid Growth and March to Profitability
One of Root’s standout features since 2023 has been its extremely high rate of revenue growth. After experiencing a period of falling revenues from mid-2022 to mid-2023, the company came roaring back and has since been posting revenue growth rates of 55% or higher on a year-over-year basis each quarter.
This rapid advance in revenues has coincided with a gradual but successful move toward profitability. The company achieved its first two quarters of positive net income in the second half of 2022. Root also became profitable on a trailing 12-month basis in Q4, reaching a full-year net income of $30 million.
Root continued to show strong growth in 2024. For the full year, it grew its policy base by 21% to a total of 414,862. This caused written premiums for the year to rise to $1.3 billion, while premiums earned nearly doubled over the prior year.
Management also pursued new growth opportunities, such as introducing its services into new states. Root currently operates in only 35 states but is laser focused on blanketing the US.
The team has also introduced a new version of its pricing model, which management claims will improve upon the predictive power of the previous model by about 7%.
Right now, Root’s trailing 12-month net margin is modest at 2.6%. As the company continues to raise its revenues, though, it’s very likely that this will expand and allow Root to better capitalize on its own growth. It’s worth noting that the company’s return on equity over the last 12 reported months was quite impressive at 17.8%.
Is ROOT a Fair Value at Today’s Prices?
One of Root’s few major weaknesses as an investment is its extremely high P/E ratio, which currently stands at 88.2.
The price-to-sales and price-to-book ratios are much more reasonable at 2.0 and 11.3, respectively. Of course, this P/E ratio is skewed by the fact that Root has only been profitable for a short time.
Given the company’s high revenue growth rate and strong future prospects, it’s possible that Root may eventually justify this rather premium pricing.
Nevertheless, analysts’ forecasts and the activity of institutional investors both suggest that ROOT shares may have become overvalued. The average target price from analyst forecasts is $96.60, a drop of more than 35% from the last price of $150.80.
The stock has even gone well beyond the highest standing price forecast of $130. In the last 12 months, institutional selling has moderately outpaced buying, and the number of shares sold has consistently beaten the number of shares bought since December.
What Could Go Wrong For ROOT Shareholders?
Beyond overvaluation, Root’s largest problem is likely its lack of a particularly strong moat. Despite its rapid growth and use of innovative technology, Root doesn’t appear to have anything that other, larger insurers would be unable to replicate. In fact, insurance majors like USAA and Progressive also have programs that use data collection to track driving habits.
Root is also still a comparatively small company competing with much larger, more established businesses. This becomes quite evident when looking at Root’s revenues when compared to some of the larger businesses in the insurance space.
Root’s revenue for 2024 totaled about $1.2 billion. Allstate, a much more mature property and casualty insurance firm, exceeded $64 billion in the same period. As such, Root remains an innovative startup attempting to take business from large, deeply entrenched competitors.
Is Root Stock a Buy Sell or Hold?
Root stock is a Sell according to the 5 analysts covering the Insurer, who have a consensus price target of $96.60 on it.
No one can deny that Root has achieved a great deal over the last couple of years. Not only has the company been able to deliver extremely strong revenue growth rates, but it has also managed to increase its share prices from under $40 per share as recently as September to over $150 today.
Most importantly, Root has been able to achieve what appears to be fairly stable profitability and has the chance to grow its earnings considerably in the years to come.
The fly in the ointment is elevated financial multiples absent a wide moat to defend them. Plus, ROOT share price has been highly volatile since the company went public in 2020. The all-time high for the stock was $486, adjusted for a 1-for-18 reverse stock split that took place in 2022.
In addition, Root persists as a net issuer of shares at a rate that could concern its existing shareholders. As of Q4, the company’s number of outstanding shares had risen 21% from the prior year. If Root sustains increases in its share count at such high rates, the dilution that results could start to work against those who already own the stock in a meaningful way.
At the end of the day, the improvements in Root’s fundamentals are extremely impressive, and the insurer may very well be worth taking a chance on at a more reasonable valuation.
In light of just how quickly shares have advanced and how high ROOT’s value multiples are, however, the risks in the stock appear to outweigh the potential gains right now.
Without a clearly defensible moat, investors may be paying too much even in light of Root’s impressive performance and potential for additional growth. As such, the stock may be better to hold than to buy at today’s prices.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.
