This Popular App Is Totally Free. Here's Why The Company Might Still Be a Good Investment

If you want to learn a new language, chances are you'll come across Duolingo's(DUOL -2.39%) app. It has been downloaded over 500 million times, is loved by people around the world, and is run by a founder with an inspirational mission to "develop the best education in the world, and make it universally available." In other words, it can be entirely free.

That's great for users, but how can that make Duolingo a compelling investment?

In this Sept. 9 video from the YouTube channel of Motley Fool contributors Brian Stoffel and Brian Feroldi, find out about the three revenue streams this company has developed, and see how the company scores on each of their investment frameworks.

Brian Feroldi: Is Duolingo a good investment? Let's run through the bull and bear case of this company to find out. My name is Brian Feroldi.

Brian Stoffel: My name is Brian Stoffel.

Brian Feroldi: Brian, for those that are unfamiliar, what does Duolingo do?

Brian Stoffel: Duolingo is a very popular app that you can use primarily to learn any language. They've got a ton of different languages, and there are millions of people who have downloaded this app to learn a second language.

Brian Feroldi: It's an incredibly popular app and it monetizes its users in three primary ways. The first is through ads. This company has millions of free users and it monetizes them through ad placements. The second way that they're monetized is through subscription services. Its goal is to convert those free users into paid users and those subscription users drive the vast majority of this company's revenue right now. The third way is through assessment tests. This company has a $49 English proficiency test that is actually acceptable at some universities in the United States. It does make a small amount of money from charging for those tests.

Brian Stoffel: What are the dynamics of the company's growth curve? As you can see, they're growing their number of active users quite quickly, up to about 37 million in the most recent quarter, but the number of users who are paying is much smaller than that right now, 96 percent aren't but four percent are. Importantly, you can look at that as a bad thing or a good thing. I looked at that as an enormous opportunity. They've only monetized four percent of this 37 million, if they can up that to six percent, and the number of users continues growing, then the amount of revenue the company collects could increase dramatically.

Brian Feroldi: What's the bull case for this company moving forward? First off, this is a mission-driven business with a wonderful founder, CEO that owns a lot of stock. The founder here is incredibly impressive individual that was also the founder of CAPTCHA and reCAPTCHA, which I guarantee is a tool that everybody watching this video has used on the internet before. Second, the name Duolingo has become synonymous with language learning. In fact, the term Duolingo is searched more than nine times more on Google than the term "learn Spanish". What's more? It's an incredible value proposition for potential learners. It's free to download and free to use. That's compelling. Third, the opportunity ahead of this business is absolutely enormous. Not only are there tens or hundreds of millions of people out there that want to learn a second language, but this company is focused on education, not just language. It has plans to move into different education categories over time, and doing so could open up new massive revenue opportunities.

Brian Stoffel: Yeah, when they came public, they really called out that it's more than just language learning, but as positive as all that is, we need to keep an eye on the bear case as well. First and foremost, how strong is the moat? In the company's prospectus, they called out the network effect as their primary moat, saying that the more users they get and the more they get them for low cost, because it's such a popular brand, the more money that they can put it into R&D, which makes their language learning tools that much more effective as compared to other possible tools. Is that true? It's hard to know. We will have to wait and see. Second is, as you said Brian, they are synonymous with language learning. That could hurt them in their move to move outside of just language learning, they do have an early literacy tool, but if they can't move beyond other educational topics, that would significantly limit their opportunity. Third, the churn is very high. This app has been downloaded over 500 million times, but currently they've only got less than 40 million active users. The reason is actually probably pretty simple, which is that once you learn a language, you don't have an incentive to continue paying or continue using this tool. We need to see them prove that this can be a sticky product over time.

Brian Feroldi: How does this company score on our checklists? We'll let you know, but before we do, we want to give a shout-out to the Motley Fool. The Motley Fool is where Brian and I met each other and we were both paying members of their flagship Stock Advisor service for years. If you're interested in checking out the Motley Fool's flagship service had a 50 percent discount. Checkout, fool.com/feroldi, or click the link that you see on the screen. 

Brian, how did Duolingo score on our checklists? For me, this company got a 71, which is already in my investable category. That's particularly noteworthy because my checklist punishes companies that have not yet been public for a year. At the time of this recording, this company has only been public for a couple of months, there is ample room for that score to improve over time.

Brian Stoffel: Mine, it got to 10, it got to 10 because I love how mission-driven, there's tons of skin in the game. I will say that when we ran this through for the hour-long episode, for The Motley Fool, I gave it an even higher score. After some consideration, I pair down the amount of moat score that I gave the company. But in the end, what I really need to see is that this company can figure out how to hang onto users and convert them to paid users if they can do that, this will be a great investment.

Brian Feroldi: Yeah, I agree. What should investors watch for this company moving forward? Well, number one thing is can it grow its paid user base. That is the lion's share of this company's revenue both now and into the future. For this company to work out, it's going to have to continue to grow that paying user piece. Two, will that optionality into other subjects actually materialized? Yes, it said that at once again to different product categories and it is already launched a new product category, but can it successfully launched those and can it convince people to pay for them. That is an unknown at this point. Finally is churn. As you said, this company's, this product has been downloaded more than 500 million times. It only has about 35 million active users. That means that the vast majority of people that have downloaded this app no longer use it. Because they don't loan or use it, that doesn't mean they're gone forever. They could come back and they could become converted customers in time, but churn is definitely something for investors to watch here. Overall, I think that we think there's a lot of things to like about Duolingo. However, it's by no means a perfect investment.

Brian Stoffel: No, it's not. What I love about it is just so hard to compete with them. They are offering it for free and that's part of their mission, but they've got to prove that you can offer for free and still be a sustainable business model, and that's what we have yet to see.

Brian Feroldi: Overall, I think there's more to like here than to not like here. It'll be a fun company to watch. Thanks for watching this video, we hope you enjoyed it. My name is Brian Feroldi and my mission is to spread financial wellness.

Brian Stoffel: My name is Brian Stoffel. My mission is to publish the rules of finance for everyone to see.

Brian Feroldi: Brians out.