Shares of Duolingo (DUOL 6.68%) have fallen by more than half since the stock peaked last fall. If you've been watching it slide, you'll be glad to know the company's foreign language learning app is a lot more successful than its stock performance suggests.
Shares of Duolingo may have risen a little too quickly last year, but there are still plenty of reasons this stock has multibagger potential for patient investors. Here are three of the most important ones.
Image source: Getty Images.
1. Duolingo users will pay
Duolingo is already extremely popular. In the third quarter last year, the company recorded 42 million monthly active users and 9.8 million daily active users.
The Duolingo app has been downloaded hundreds of millions of times because it allows potential subscribers to take online lessons and track their progress for free. A key reason to buy this stock on the dips is the company's impressive ability to convert free users into paid subscribers.
The company ended the third quarter with 2.2 million paid subscribers, and this figure is rising much faster than active users with free accounts.
| Operating Metric | Dec. 31, 2019 | Sep. 30, 2021 | Percent Change |
|---|---|---|---|
| Monthly active users | 27.3 million | 41.7 million | 53% |
| Daily active users | 5.2 million | 9.8 million | 88% |
| Paid subscribers | 0.9 million | 2.2 million | 144% |
Data source: Duolingo.
Customer retention is a key concern for any subscription-based business, especially educational apps directed at consumers. Signs suggest the company's hanging on to a lot more learners than you might expect. An impressive 80% of Duolingo's paid subscribers choose 12-month subscriptions upfront rather than pay month to month at a slightly higher rate.
2. Getting better all the time
Duolingo's subscription model is popular enough that the company doesn't need to bombard its free users with advertisements. In the third quarter of 2021, just 14% of total revenue came from ads. The advertisement light business model gives the company a lot more insight into what drives user engagement than the company would have otherwise.
At the moment, it looks like the virtuous cycle created by its advertisement-light operation is working. Gleaning insights from all the data the popular smartphone app collected already produced a highly effective product. A recent peer-reviewed paper showed that people who completed five units of French or Spanish on the Duolingo app can read and write just as well as university students with four semesters of coursework under their belts.
Duolingo is investing heavily to make its application the most popular way to learn a language, but that isn't the only way it makes money. Duolingo also offers an increasingly popular English proficiency test that generates around 10% of total revenue. At the end of last September, all of the top 25 U.S. universities in terms of international student volume were accepting Duolingo's test as proof of English proficiency for international undergraduate admissions.
3. Thanks, Google
Duolingo can just about guarantee a significant earnings bump in 2022. That's because Alphabet, Google's parent company, decided to do its Play Store partners a solid and cut its 30% transaction fee in half beginning Jan. 1, 2021. Duolingo earns around one-fifth of total revenue from Google Play Store subscriptions.
Apple has already cut its App Store tax from 30% to 15% for developers with less than $1 million in annual revenue. If Apple decides to follow Alphabet's lead and reduce its Duolingo's fees, it could be a huge boost. The company derives more than half its revenue from the App Store at the moment.
Duolingo doesn't need any relief from Apple or Alphabet to make ends meet. Over the past year, the company reported $6 million in free cash flow.
Noncash expenses associated with the company's initial public offering last July led to a net loss in 2021. With that out of the way, I'll be surprised if strong profits don't cause the stock to rise in 2022 and beyond.
