What happened
File this story under the rubric: Easy come, easy go.
Last week, shares of Duolingo (DUOL +3.89%), which offers a free-to-play language learning app, soared more than 13% over two sessions as investors reacted to a bullish note from Needham. Today, however, Duolingo shares gave back all of those gains, falling 14.3% through the closing bell.
And once again, it was an analyst note that sparked the move.
NASDAQ: DUOL
Key Data Points
So what
In Needham's note last week, the analyst made the argument that Duolingo is now the leader in the online language learning market, which could be worth as much as $49 billion in annual sales. The company's "gamified learning platform," which is free to use initially, offers Duolingo multiple ways to grow its revenue -- selling subscriptions and in-app digital items to its users, as well as selling ads that it can display to those users in between lessons, for example. According to StreetInsider.com, Needham also predicted that Duolingo will expand beyond language instruction to offer online programs in the subjects of "literacy & math."
These predictions, along with a $115 price target, sent Duolingo shares flying last week. But today, a second analyst -- KeyBanc -- curbed investors' enthusiasm with a warning that Duolingo stock had run up too far, too fast.
As Duolingo stock rocketed past $110, KeyBanc warned that the stock now trades at a valuation that is more than twice as rich as its peers -- nearly 10x sales. But with inflation rising and investors no longer as willing as they once were to pay large multiples to sales for unprofitable companies, KeyBanc thinks Duolingo's potential to continue rising is now limited -- and so it downgraded the stock to "sector weight."
Now what
Investors didn't like hearing that today at all. But are they right to be concerned?
For the past several weeks, investors have worried about "inverted yield curves" and rises in the Federal Reserve's targeted interest rates -- two factors that both have a lot of folks wondering if the economy might be barreling toward a recession. Recessions aren't generally good news for companies dependent upon advertising, as ad budgets are often among the first line items to get cut.
But here's the thing: At Duolingo, advertising only makes up about 15% of revenue. The vast bulk of the company's income comes from sales of subscriptions to its services, and those subscriptions should be more recession-resistant than ad revenue. Those subscriptions are also the exact kinds of revenue Needham was pointing to last week as avenues for growth at Duolingo, if it decides to expand the subjects it teaches.
While I'm probably the last person you'd expect to recommend investing in an unprofitable tech stock that's richly valued in terms of sales, the simple fact of the matter is this: If you liked Duolingo last week, nothing KeyBanc said this week has changed that story.
