Although there have been lots of ups and downs, Chegg (CHGG -1.45%) has outperformed the broad market in 2019. Year to date, the stock is up about 34% as of this writing. Despite this performance, there's something else investors should be excited about.
Many companies can provide strong returns for a relatively short period of time, but to do so in the long run, it is necessary to build sustainable competitive advantages -- also known as a moat. Not content with its gains this year, Chegg seems to be building a moat before our eyes.
The more the merrier
There are various sources of a sustainable competitive advantage, including the intangibles a company possesses -- its patents or its brand name. Coca Cola is one such example: The company's famous logo is a stamp of approval on any nonalcoholic beverage, and that alone can drive consumers' demand for said beverage. A company can benefit from other advantages, such as high switching costs or network effects, and it is in the latter of these categories that Chegg is building its moat.
The network effect occurs when a product or service becomes more valuable as more people use it. Chegg describes itself as the "leading direct-to-student learning platform to improve educational outcomes." Consider, for instance, Chegg's Tutor services. Tutors want to find as many clients as possible, whereas students want to find tutors who can best cater to their needs, something that becomes easier as the number of tutors to choose from increases. In other words, the more students there are looking for tutoring services on Chegg, the more tutors will want to sign up to offer their services on the platform, thus making it easier for students to get the help they need.
Chegg's Study service -- where experts answer questions students have about a particular subject -- can benefit from a similar dynamic: The more experts there are, the more students look for answers to their questions on the platform. And the more questions students ask, the more experts looking to share their knowledge flock to help. In short, Chegg's moat gets stronger (more tutors and experts) as its platform grows larger. Further, once students sign up for one of Chegg's services, they can benefit from others as well. For instance, the company offers textbooks for sale (or for rent) at affordable prices.
It is worth noting that Chegg faces competition across the range of its services. For instance, the company cites free offerings from Yahoo! Answers and Brain.ly as competitors to its expert service. Chegg also faces competition from services such as Wyzant in tutoring, and there is no shortage of textbook rental services with Amazon being perhaps the most prominent name in this space. However, none of Chegg's competitors boast the expansive, complementary suite of student services the company offers. Despite its current total subscriber count, which exceeds two million, Chegg still has room to grow. The company is tapping into a market of 36 million high school and college students in the U.S. alone, not to mention largely unexplored international opportunities.
Chegg's business model seems to be working well. During the third quarter, the number of subscribers for its core Chegg Services (which includes Chegg Study, Chegg Writing, Chegg Tutors, and Chegg Math Solver) increased by 29% year over year, and Chegg's revenue increased by 27% compared to the year-ago period. Lastly, Chegg benefits from high margins: The company's gross margin for the quarter was about 76%.
Can Chegg keep it up?
As college costs continue to rise, Chegg is hoping to make the learning experience significantly easier for students. The company is building a strong brand name as the "go-to" platform in education. During the third-quarter earnings call, CEO Dan Rosensweig said, "In a short period of time, Chegg has achieved 87% brand recognition, is growing globally, and we continue to expand the quality and quantity of services we offer students."
One way in which Chegg recently expanded its offerings portfolio was with the acquisition of Thinkful -- an online platform that offers courses to professionals -- for $80 million in an all-cash transaction. With this acquisition, Chegg is looking to tap into the market of working adults looking to kick-start or advance their careers by going back to school (the average student on Thinkful is 30 years old, and about 66% of them are employed). With this opportunity added to its core services, Chegg should continue growing, and investors looking for growth stocks worth buying would do well to keep an eye on the company.