Language is core to cultures worldwide and a valuable skill in business, traveling, and meeting new people. But the process of learning a language has been somewhat antiquated for some time.
Learning app company Duolingo (DUOL 3.64%) is changing that by gamifying learning with artificial intelligence (AI) and a vibrant user experience. The company's stock has been on a bumpy ride after its IPO in 2021, but it could soon be ready to take flight.
Here is why there's plenty to be excited about moving forward and whether the stock is priced right for your portfolio today.
Rapid adoption by gamifying learning
Duolingo is a learning smartphone app where you can learn and practice speaking different languages. Users can complete a series of lessons to earn points, compete in contests, make and connect with friends, and more. The app will tune lessons using artificial intelligence based on your existing skill and your performance during lessons.
People are flocking to the app; monthly active users were 74.1 million as of the second quarter of 2023, up 50% year over year. The app prompts users to do at least a daily lesson, encouraging steady engagement. This seems to work, as daily active users grew 62% year over year in Q2 to 21.4 million.
The education industry is stagnant, and people traditionally rely on in-school classes to learn a foreign language. There have been some digital innovations, including Rosetta Stone, a computer software program popular in the 1990s and 2000s, but it faded and was acquired. However, Duolingo has seemingly disrupted the industry by making language learning fun with its game-like model.
Strong financials beneath the surface
Duolingo is free for users, which is one of the cool aspects of the product. Users can learn a language without spending a dime. However, you'll see ads between lessons and be forced to wait for replenishment if you run out of hearts (you lose a heart by getting a lesson question wrong). Users can purchase Super Duolingo, a paid subscription that unlocks more features, including no ads and unlimited hearts.
Investors should like what they see in Duolingo's financials. The company is growing revenue faster than 43% year over year, and expenses like marketing and research and development are steadily shrinking as a percentage of revenue. This is called operating leverage, and it points to Duolingo becoming an increasingly profitable business as it keeps expanding.
DUOL Revenue (TTM) data by YCharts
Additionally, the business is free-cash-flow positive, converting 27% of sales to cash flow through the first half of 2023, or $34 million. The company has $678 million in cash on hand and zero debt.
Shares could be worth their price tag
There's a lot to like in Duolingo's fundamentals, which could explain why the stock carries a hefty price tag. Shares trade at more than 12 times revenue, which values the company alongside highly regarded enterprise software stocks like Monday.com and CrowdStrike. Duolingo probably needs a long runway for growth to justify its lofty valuation.
The ingredients are there for it. Only 7.9% of users pay for Super Duolingo, so there's room for increased monetization and continued user growth. The company is also rolling out Duolingo Max, an additional tier above Super Duolingo that uses AI to introduce a new level of interactions, such as role-playing. Education isn't limited to languages -- Duolingo Math is a new app that breaks Duolingo into a new category. If replicating its formula proves successful, there isn't any reason the company can't go into new categories down the road.
The stock's $5 billion market cap means it's still small enough for investors to pay a premium for a high-quality and growing business and let it grow into that valuation over time. Duolingo isn't a bargain by any measure, but its bright future makes the stock interesting today, at the very least.
