One Stock David Gardner Thinks You Should Watch

If you had a strong desire to learn Portuguese, you could spend some time in Mozambique, try to find a course at your local community college, immerse yourself in a Berlitz class, or pick up the yellow box from Rosetta Stone (NYSE: RST  ) . The company has built a strong reputation for teaching new languages relatively painlessly and affordably, making it the brand-name leader without rival. As Fool co-founder David Gardner says, "I can't find the Pepsi to Rosetta Stone's Coke. There's no comparable competitor."

That's a large part of the reason David thinks the company -- which shoots to make learning a language fun, easy, and effective -- has the potential to be a 10-bagger. It shares many of the characteristics of some of David's very best recommendations, specifically:

  • It has a purpose and a mission that is important and relevant.
  • It is an undisputed leader in its field.
  • It has created a brand and identity that resonates directly with consumers.

The company started with an idea and developed an innovative solution. Instead of parsing sentences, conjugating verbs, and memorizing vocabulary lists, the millions of people who use Rosetta Stone software learn through something the company calls dynamic immersion, which incorporates images, text, and sounds to teach using the natural language learning ability we had as kids.

And the 8-year-old company would seem to have its greatest opportunity ahead of it. It's just starting to develop its international presence. Fully 95% of its 2008 revenue came from the U.S., even though the U.S. accounted for only $2 billion of the $32 billion spent worldwide in 2007 on language self-study.

With an average sales price of $355, Rosetta Stone's software makes learning a foreign language relatively affordable for motivated learners, but it still carries a high gross margin north of 85%. With that kind of margin and strong organic growth potential -- both internationally and domestically in what remains a relatively fractured market -- Rosetta Stone should be able to grow profits as it gains scale.

Grandes empresas ("big business" in Portuguese)
And that's just on the individual consumer side. Many organizations see expanded language skills as a competitive advantage and incorporate Rosetta Stone programs into their training and development. Arcelor Mittal (NYSE: MT  ) , the world's leading steel company, has a presence in more than 60 countries and a diverse workforce.

"We have people relocated to foreign countries, and three or four months before going, they register with Rosetta Stone," said Vincent Maurin, ArcelorMittal's e-Academy lead. "They are able to learn more of the language before they go, and they arrive with the ability to hold basic conversations."

Thomson Reuters (NYSE: TRI  ) offers 29 languages to more than 50,000 learners around the world, with no restriction on which language employees can study.

And InterContinental Hotels Group (NYSE: IHG  ) offers Rosetta Stone as a way of bolstering the hotelier's customer service. "[I]t is important that we promote access to tools and resources that can narrow the communication gap with customers, clients, stakeholders, and team members," said Gary Whitney, VP of global hotel learning at IHG.

For personal, corporate, and governmental customers, Rosetta Stone's innovative origins remain today as the company constantly seeks to build features that allow it to make the learning process easier, more fun, and more accessible for its lovers of language. While Berlitz stretches only as far as audio CDs, a Rosetta Stone package of Level 1 and 2 Portuguese -- retailing for $399 and designed to build intermediate-level conversational skills -- comes with interactive software, an audio companion for your MP3 player, a headset and microphone for use with its speech-recognition software, live online sessions, games, access to its community, and a mobile companion for learning on an iPhone or iPad Touch. The idea behind the product extensions -- a subscription model the company tags Version 4 Totale -- is to build more engaging and longer-term relationships with its customers.

What to watch
But not everything is sol e pirulitos ("sunshine and lollipops" in Portuguese) for Rosetta Stone. The company, which went public in April 2009, took a hit later that year, when it canceled a secondary offering and lowered earnings guidance, citing ill-spent sales and marketing costs and higher-than-expected product development expenses -- not exactly the quick jump off the public starting blocks that analysts like to see.

More recently, the company's CFO resigned and the COO followed him out the door, raising some questions in David's mind about Rosetta Stone's culture. While he likes CEO Tom Adams (who has been running the company since 2003 and is still under 40), David wants to see a sense of stability and maturity among the leadership, along with a shift away from its unfortunate approach of overpromising and underdelivering on its financial results.

Overall, though, Rosetta Stone's biggest gambles on the table seem to be good ones. Though available on the market for only two weeks before the end of its third quarter, Version 4 Totale subscriptions accounted for 19% of total revenue for the quarter, a very promising trend. And its foray into the rest of the world is playing out in the early stages like the huge opportunity it initially appeared to be. International sales for the third quarter increased by 119% from the same period the previous year, yet revenue from outside the U.S. still makes up only 17% of total revenue. Turns out a lot of folks around the world want to learn English.

With a vast advantage in brand recognition, an evolving business model that appears to be paying off on two significant fronts, and a world of people who want to communicate with more people than they can in any one language, Rosetta Stone is definitely worth keeping an eye on.

Catalysts

  • Keep an eye on turmoil in the management suite. Two high-profile departures make a line; three could indicate a trend.
  • Monitor the progress of international and subscription services. The company has plotted a big chunk of its future on these bets, so make sure the growth continues on both fronts.
  • Management has made a habit of disappointing the market, and its stock performance has been whiplashed as a result. There's a reasonable chance that shares will take another hit at some point, which could present a buying opportunity for what remains, despite management missteps, an outstanding business.

You can make smarter investing decisions with your own version of My Watchlist, new and free from the Fool. Click below to start following Rosetta Stone:

Roger Friedman doesn't own shares of any of the companies mentioned, but they’re now on his watchlist. Rosetta Stone is a Motley Fool Stock Advisor recommendation. Coca-Cola is a Motley Fool Inside Value selection and a Motley Fool Global Gains pick. Coca-Cola and PepsiCo are Motley Fool Income Investor selections. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Coca-Cola. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (36) | Recommend This Article (97)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 24, 2010, at 2:20 PM, taplinger wrote:

    I hope David is right, and he probably is. However, my experience with Rosetta Stone a few years ago was pretty bad - I used it for an upcoming trip to Italy - it was fun and easy except for one thing - when I got there it didn't help. Maybe it was me, maybe I needed the advance lessons also - maybe your readers could say whether it helped them or was just fun and easy compared to traditional teaching methods. Also, they use photos in their lessons, and a lot of the photos were taken in Harrisonburg, Virginia where their office is instead of in the country you're going to. I thought that was pretty cheesy, and then at the airport on the way home I stopped at a Rosetta Stone kiosk and saw they use the same generic photos for every language. Considering what they charge, that's primative. Good news - they offer a 100% money back quarantee and they gave it to me with no problem.

  • Report this Comment On December 24, 2010, at 2:28 PM, TMFSunshine wrote:

    Well, having gone to school at James Madison University in Harrisonburg, I can say it's lovely. However, I agree they probably could invest in some more international photography.

    More importantly, I'd love to hear other people's experiences with learning a language with Rosetta Stone. Does it work? Do you wind up conversant? Were you able to do more than ask where to find the bathroom?

    Thanks for the comments, taplinger. - Roger

  • Report this Comment On December 24, 2010, at 5:03 PM, Merton123 wrote:

    The challenge with small cap opportunities is that there are no margin of safety if the future growth opportunity doesn't materialize. The rosetta stone is currently trading at a trailing P/E ratio of 17. If I was managing the Motley Fools "American Fund", I would approach Rosetta Stone about issuing a convertible bond. The company gets the money for its expansion. And if the growth scenario occurs then "American Fund" could exercise the associated stock warrants and the convertible debt liability of Rosetta Stone is eliminated. If the growth doesn't occur then "America Fund" downside risk has been covered by the convertible bond. Mert

  • Report this Comment On December 24, 2010, at 5:12 PM, TecmoBowl wrote:

    Livemocha.com is the same thing and free. I don't see the competitive advantage I guess. Why pay a fistful of cash for something you can get online for free?

  • Report this Comment On December 24, 2010, at 8:10 PM, dandles2020 wrote:

    livemocha looks interesting, thanks for the tip. I took French in college and have thought about getting the Rosetta discs, but they are a bundle. The first thing i thought was, "Why don't they have something on the web?" I think that's the way people are interested in learning now.

  • Report this Comment On December 24, 2010, at 10:01 PM, Blueman1000 wrote:

    I actually work as a Senior Director of an adult educational school of English as a Second Language with nearly 500 students from some 47 countries. Latin America, France, Germany, China, Viet Nam, and the Middle East. Forget about being a stock market expert, these teach yourself programs just don't work. Period. Rosetta is doing a great job with advertisements, and I'm sure people are mastering a lot of open ended phrases, but that's all. I would pass.

  • Report this Comment On December 24, 2010, at 10:09 PM, Merton123 wrote:

    The consensus that I am getting from the posts are:

    1. There are products that do a better job then Rosetta.

    2. The barriers of entry are minimal.

    The only other remaining reason to buy is if the investor believed that this company would be a good takeover candidate. Otherwise this company will eventually go private since earnings growth is necessary for continued interest. Mert

  • Report this Comment On December 24, 2010, at 10:50 PM, topsecret10 wrote:

    Management In disarry... hurry hurry,run away !

  • Report this Comment On December 24, 2010, at 11:14 PM, sachiv100 wrote:

    with Android, iphone, and ipad apps - it seems other providers will overtake rosetta stone's PC software with the added convenience of having the software with you WHEN YOU NEED IT! (however much better rosetta stone's software is)

  • Report this Comment On December 24, 2010, at 11:40 PM, ipapajoker wrote:

    evidently dandles2020 is a sales rep for Livemocha... which is NOT FREE>>> we do not need this type of bullpuck in this association...papajoker

  • Report this Comment On December 25, 2010, at 1:20 AM, TecmoBowl wrote:

    Papajoker that was me who mentioned livemocha not dandles. Livemocha is indeed free though, but they do have select lessons that you can pay for as well. The free content is a very good start though, and honestly just as good as the RosetaStone software.

  • Report this Comment On December 25, 2010, at 2:02 AM, brewersfan81 wrote:

    I've written many stories about RST for TMF, and I consider myself a big believer in them. People mock the "immersion" approach as simplistic and ineffective. In reality, that's the point. When we learn a new language as babies, we don't learn them through conjugation tables, we learn them through continued, varied interactions (visual, verbal, auditory, tactile).

    My spouse and I have been living/traveling extensively in Central America for months now, we own versions 1-5 (LA Spanish), and swear by the product. No, it won't make you instantly fluent. But anything that says it will is simply lying to you. You get to work at your own pace, and if you're willing to put in 45 min-hour every day, you'll make significant progress.

    Of all the people who say it doesn't work, out of curiosity, I'd like to know how many of the 5 levels were completed.

    Brian Stoffel

    LONG RST

  • Report this Comment On December 25, 2010, at 11:25 AM, none0such wrote:

    I think that there is a trend that will squash this company. There are businesses that hook up native-speaking language tutors to learners via the web complete with downloadable material. I don't know how effective this model is (at teaching or making money), however, but it is certainly an authentic language experience - something this software doesn't supply at present. Perhaps these technological answers to language learning will complement classroom based learning, perhaps not. One final point I'd like to make is that emerging economies (those that may not attract many native speakers of languages to teach or are situated far from traditional classroom settings) have adopted cellular phones more than computers. As a result, this delivery system for language learning has high potential for explosive adoption for those wanting to learn English throughout the world.

  • Report this Comment On December 25, 2010, at 11:55 AM, Merton123 wrote:

    Investing is about uncertainty. There are some people who believe that Rosetta Stone will grow, and there are others who believe that Rosetta Stone will not grow. Does anyone want to discuss "shorting" Rosetta Stone stock?

  • Report this Comment On December 25, 2010, at 12:52 PM, langco1 wrote:

    all of the educational stocks had a great run but peaked midway through 2010 and are now in a multi year decline.....

  • Report this Comment On December 25, 2010, at 1:50 PM, belchmeyer wrote:

    i have a lot of respect for David. Every time i'm think david is wrong I've been burned. that being said. I am an intermediate spanish speaker and have tried both pimsluer and rosetta stone. I learned a lot more from the audio version of pimsluer spanish than I did rosettta stone,a nd it's only an mp3 player away. I did learn more vocabulary from RST.

  • Report this Comment On December 25, 2010, at 7:20 PM, Gr8Writer wrote:

    That's a pretty broad statement, langco1. I bought BPI -- an educational stock -- in August '10, and it is up 12% since then. Multi-year decline you say? Not here.

  • Report this Comment On December 25, 2010, at 7:26 PM, Merton123 wrote:

    I talked with my sister today and she said that she was thinking about buying Rosetta Stone software. Based on Peter Lynch guidelines for finding a good company having close friends and family buying the product is a good sign. I don't like Rosetta Stone because there are no repeat sales to the same customers. Roseta Stone depends upon getting new customers every year. I prefer Netflix who can sell to the same customer base every day. Netflix does have a very high P/E ratio so I would wait until Mr Market panicks and gives me this Net Flix for a PE less then 20.

  • Report this Comment On December 25, 2010, at 9:06 PM, brewersfan81 wrote:

    I feel like there's a lot of misunderstanding about RST on the board.

    @Merton123-They DO provide a subscription based model now, with the release of their Version 4 Totale.

    @nonesuch- RST has just rolled out iPad and iPhone apps that will be usable on smartphones. Eventually, I hope this extends to all types of smartphones.

    Beyond that, I think a lot of people are judging RST based on previous versions. I own Version 4. It offers real-time, online coaching sessions with native speakers to go along with it's traditional offerings.

  • Report this Comment On December 25, 2010, at 9:23 PM, dandles2020 wrote:

    brewersfan81. Thanks for clarifying that information about Rosetta. I had been thinking of getting the discs to brush up on my French from college. I like the idea of something that has apps and online coaching sessions. I want to look into this further, because I had put this stock on my watch list based on the last time Motley Fool recommended it.

    And no ipapajoker, I am not a rep for livemocha, you are way off base on that one. I just thought the site looked interesting based on someone else's mention of it. If Rosetta offers some online coaching and a community, which it seems to, my interest would swing back toward Rosetta.

  • Report this Comment On December 26, 2010, at 12:51 AM, Merton123 wrote:

    Brewersfan81 - I also thank you for clarifying the information about Rosetta. The subscription model and online coaching make this a very attractive program. I could see the public school systems becoming interested in such a program to help students become bilingual. We live in an incredible country which provides the means for anyone to achieve almost any goal that they set for themselves.

  • Report this Comment On December 26, 2010, at 7:22 AM, Merton123 wrote:

    I believe that a company can be offering a wonderful product but may not necessarily be a good investment. Lets examine Rosetta Stone from a Benjamin Graham perspective.

    1. The first step is to ask if we have no earning growth what is our margin of safety? The stock is trading at $20.55/share the EPS is $0.70 Cents for a P/E ratio of 29.26. A large cap stock which has no earnings growth normally trades around a P/E ratio of between 8 and 9. You take $0.70 EPS multiply by 9 and you get $6.30/share. The downside risk for this stock is the difference between $20.55/share and 6.30/share if RST was a large cap stock.

    2. Has RST saturated its market niche? How many people in your circle of friends want to learn a new language? Of that group how many have already purschased Rosetta Stone? An alternative approach would be to ask the sales people at your local Barnes and Noble is Rosetta Stone still selling at a brisk pace after the Christmas Season. If the answer is no - You are looking at a potential 70% loss in your investment if this was a large cap stock.

    I would like to contrast RST with Amy's Frozen Food which unfortunately is not a publically traded company. I talked with the sales people at my local Walmart and they told me that one of their fastest selling products is the vegetarian Amy's frozen food. This is a product that is consumed every day. As people want to eat more healthy they will transition to food like Amy's Frozen Food. While this may not be as sexy as Rosetta Stone. This is the type of investment that Warren Buffet would love.

  • Report this Comment On December 26, 2010, at 8:05 AM, Merton123 wrote:

    I have placed RST on my CAP list to underperform the market. We can improve our CAP rating by predicting "EITHER" over performance or under performance of a stock.

  • Report this Comment On December 26, 2010, at 5:46 PM, moser1 wrote:

    I haven't heard anyone discuss the prospects of international sales teaching English to others. David mentioned a world-market of $16B in annual sales. This sounds like a strong argument in favor of the stock. How do others see ethos as a growth catalyst for the company?

  • Report this Comment On December 26, 2010, at 5:48 PM, moser1 wrote:

    Sorry...typing on an iPhone...Meant to say "Do others see this as a growth catalyst for the company?"

  • Report this Comment On December 26, 2010, at 5:52 PM, TNT2011 wrote:

    I'm no expert, but I think the author is completely wrong about Rosetta Stone. I have their product for two languages: Chinese Mandarin for my study, and American English for my Chinese son. The breadth, depth, and size of the courses are far too limited given the price. And the add-on levels (if they exist) are inappropriate for the audience. 10-bagger? My opinion is it would take five years even to double, even if they DO double. In addition, the nearly free language apps for the iPhone are superior, and render Rosetta stone obsolete. For a fraction of the price of the Chinese course, I have many, many wonderful apps for learning Chinese. The same exists for other languages. Their business model is flawed--I don't think they even know their audience.

  • Report this Comment On December 26, 2010, at 10:03 PM, jweissman wrote:

    My intuition says this is not a good stock, tho it is a good product. Pimsleur, IMO, is better, and I've tried many programs. But even if Pimsleur (owned by Simon & Schuster) was a stock it too would not be a good bet. Once you reach intermediate level you can, more or less, stop using the programs--unless you have zero chance of speaking with native speakers, a practice which will supercede any program very quickly for cultivating fluency--the goal of all language learning. It should be noted Rosetta is not good for illiterate, or barely literate learners because it is at it's best when used with both images and text. (BTW, we may immerse a new language in our minds--merely by studying a lot--but we cannot "immerse" our selves in a language, not without translation, which occurs explicitly, as with Pimsleur, or implicitly, as with Rosetta) ...space prohibits more)

  • Report this Comment On December 27, 2010, at 9:00 AM, hendrixharlow wrote:

    Very low barriers to entry in this market. Take for example, Fluenz--they offer Mandarin, Spanish, French, and Italian and were essentially founded 3 years ago. Personally I think they do a much better job than Rosetta stone. In addition, vocab practice can be found freely almost anywhere on the internet. This is a very very risky stock imho.

  • Report this Comment On December 27, 2010, at 10:06 AM, craniotomy wrote:

    I'm not sure, but I heard a few years ago that several software companies were working on computer based translations ... what happens if processor speeds double, and double again?? Pretty soon we might get "Star Trek"-like "universal translators," thereby eliminating the need for learning languages! Now that would be a Clay Christiansen disruptive innovation!!

  • Report this Comment On December 27, 2010, at 2:53 PM, Popnfresh100 wrote:

    Fluenz, Fluenz Software is the Pepsi to Rosetta's Coke.

    That being said, I agree that Rosetta should do really well.

  • Report this Comment On December 29, 2010, at 3:03 PM, susan400 wrote:

    RST ---catchy business sounds good,

    but too many buy and really don't advance.

    i have been short since teh IPO and stay short

  • Report this Comment On December 29, 2010, at 3:26 PM, susan400 wrote:

    its like exercise memberships,,, everybody sign

    but in the end no one goes

  • Report this Comment On December 29, 2010, at 6:17 PM, polenium wrote:

    It might be a good play if Rosetta Stone's products were of good qualtiy. My information, from several people that used them, is that they are not.

    Which brings to mind another Fool principle; invest in what you know.

  • Report this Comment On January 02, 2011, at 2:01 PM, minitasha wrote:

    Livemocha sounded really interesting but the only free access I found online was a free trial. Anything else starts at $14.95...not bad maybe, but not free.

  • Report this Comment On January 02, 2011, at 4:04 PM, Kymera wrote:

    While Rosetta Stone may be a very good product, I just cannot see it moving to great heights anytime soon.

    This is a relatively expensive product that requires a significant amount of time and effort by the person purchasing it, to even make it useful. Then, I am really not sure how many Americans are passionate about learning another language unless they are traveling to another country.

    While I have not used Rosetta Stone, I have used Pimsleur. With Pimsler, for about $120 a level you get a great audio product that you can use anywhere to practice and become proficient relatively quickly. Not sure Rosetta Stone would be worth the extra bucks.

  • Report this Comment On October 20, 2012, at 10:19 PM, clbjblk wrote:

    Did you ever try to teach your dog a new trick when it is set in it's ways you already taught him or her, with voice commands in a different tone is proven you should have incorporated that in your initial training, of coarse everybody wants to learn English look how long before the first tea party we could be speaking French or Spanish etc. but the best is sign language that is international. It is like southern slang or Ebonics or Calif PAY YOUR TAXES we know there language no harm meant but to be fluent you need to get in the street in what ever country you are in, or your name is Mark because that is what you are a Mark unless you have your name on the back of your shirt. There are no short cuts so just pay someone unless you grew up with it.DENADA

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