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David's Stock No. 1

Rosetta Stone

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 David 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 feels 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, users of Rosetta Stone software -- of which there are millions -- 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.

Just Getting Started

And the nineteen-year-old company would seem to have its greatest opportunity ahead of it. It's just starting to develop its international presence, even though the United States accounted for only $2 billion of the $32 billion spent worldwide in 2007 in an attempt to learn a language through 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 80%. 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.

Additionally, its 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's Not to Like?

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 il