Lemonade (NYSE: LMND) has largely disappointed investors over its four years as a public company. It fell 73% from its first day’s closing price, failing to meet profitability expectations. However, if you bought at the right time, you would have already benefited from owning it — it’s up 67% in the past year.

There are all kinds of factors that influence how stocks move in the short term, and one of the most important is earnings. Lemonade reports third quarter earnings on Thursday, October 31st. Depending on the results, Lemonade could move up or down, and that could be significant. Should you buy before the earnings release?

What is lemonade about?

Lemonade operates year round insurance company built on a digital substrate and informed by artificial intelligence (AI) and machine learning. It’s a mouthful and it actually means that the company is using AI technology to make insurance in a better way.

Does it work? The verdict is not out yet, but there are reasons to be confident. Lemonade was built in a different way than legacy insurers, with an interconnected system that speeds up the information gathering and underwriting processes.

How this is achieved from the consumer side is that instead of a laborious process that involves an agent, Lemonade onboards customers and pays claims via chatbot. On the business side, Lemonade’s algorithms work through machine learning to keep improving organically and come up with accurate policy rates.

The concept attracts customers. It has more than 2 million customers at the end of the second quarter, and its premium in force is up 22% year over year.

What’s less impressive is Lemonade’s loss rate and its net losses. Loss ratio measures how much a policy pays out in claims, and should decrease as algorithms improve. It hasn’t been a linear process, and every quarter, the loss rate is what investors watch.

Image source: lemonade.

The loss ratio improved 15 percentage points year over year in the second quarter, the best improvement in three years.

The other pain point for investors is the net loss. Management said it is past peak losses but is still up to $57 million in the second quarter.

However, management predicts that as it expands, its reliance on technology instead of headcount will drive profitability. Its revenue is still a fraction of the big insurers, but as it grows, its technological edge should give it a major edge over the competition.

What could happen on Thursday?

Growth was strong across the board, from revenue to gross premium earned to premium per client. So let’s focus on what the market will be watching this week, the loss rate and the take profit values.

Lemonade doesn’t give an indication of the loss rate, but based on the chart above, you can see that it was 83% in the third quarter of last year and has been better for the past three quarters. If it stays below 80%, which would be at least four percentage points better year-over-year, the market should be happy.

In terms of profitability, it still has a way to go. Management provides approximately $57 million in adjusted earnings before interest, taxes, depreciation and amortization (EBITDA), which is up from $40 million last year. Wall Street it expects a loss per share of $1.03, and often the hits and misses here dictate how the stock reacts to the earnings release.

Not all stocks are heavily affected by earnings reports, but take a look at how Lemonade’s stock fared after recent earnings reports:

LMND given by YCharts

Although it had a significant short-term reaction each time, it corrected quickly enough to get back in line each time except for the third quarter of 2023. It rose and stayed there, accounting for most of of his earnings in the last year. You can see how the stock rose each time in anticipation of good news and then fell. This is already happening in anticipation of this week’s results, but not as much as last quarter.

That puts investors in a good position. If the results are poor, the stock will go down, but it won’t be a disaster like in July. If they are well-received, the stock could seriously rise and stay there until the next round of good news.

The odds are in your favor, both short-term and long-term. In the short term, because the gain from good news is likely to be stronger than a fall from bad news. In the long run, Lemonade has a disruptive business that has overcome the barriers to entry that legacy insurers have propped up with their huge fortresses. It has a bright future if its algorithms start to outperform traditional insurance companies. There’s no guarantee that will happen, and this is a stock for investors with an appetite for risk.

Investors should focus on the long term, but if Lemonade stock rises after earnings, now could be a great entry point.

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Jennifer Saibil has positions in Lemonade. The Motley Fool has positions in and recommends Lemonade. The Motley Fool has a disclosure policy.