What happened
Shares of Duolingo (DUOL -0.71%) soared as much as 17.4% this week, according to data from S&P Global Market Intelligence. The language-learning application posted strong growth across all its key metrics and is starting to generate healthy cash flow, leading investors to bid up its shares. As of 1:23 p.m. ET on Friday, May 12, shares of Duolingo are up 15.2% this week.
So what
Duolingo released its Q1 earnings earlier this week on May 9, and all its key numbers looked incredibly strong. Monthly active users (MAUs) grew 47% to 72.6 million, and daily active users (DAUs) grew 62% to 20.3 million. This led to a strong 63% bump in paying subscribers to 4.8 million, which drove bookings growth of 37% to $140.1 million in the quarter.
The company reported a net loss of $2.6 million, but this understates the company's true profitability. Since Duolingo sells subscriptions, it has to recognize revenue over the life of these contracts, even though it collects the cash up front. This is why it reports bookings, which is a top-line sales number based on cash collections, instead of GAAP revenue (generally accepted accounting principles).
Long story short, even though Duolingo is reporting net losses, it generated around $28 million in free cash flow in Q1.
For the full year, Duolingo expects bookings to hit just over $550 million and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to hit just over $55 million. With the stock up so much after the report, this guidance likely significantly beat investor expectations heading into the announcement.
Now what
Duolingo has come out firing in 2023, with shares up almost 100% through the first few months of the year. At a market cap of $5.8 billion, shares trade at a forward price-to-earnings (P/E) ratio of over 100 based on its forward EBITDA guidance. This is expensive no matter how you slice it.
However, investors should understand that with very high gross margins (72% last quarter), it is likely that Duolingo's profit margins will expand as it matures over the next few years. If the company keeps growing bookings at a healthy double-digit rate and expands its margins, this will lead to rapid growth in profitability.
Anyone looking to buy shares today needs to expect both things to happen in the next few years. Otherwise, it looks like Duolingo stock is overvalued.
