Up by a whopping 125% year to date, Duolingo (DUOL 3.64%) stock has richly rewarded near-term investors. While the language learning app's freemium business model initially looked hard to monetize, management seems to be on the path to sustainable profitability. Let's explore how the situation could develop over the next five years.
What is Duolingo?
Founded in 2011 and going public in 2021, Duolingo operates its namesake language learning app, available on IOS and Android. From personal experience, the platform is very similar to legacy language learning software like Rosetta Stone. But Duolingo disrupts this market through a freemium business model where the most valuable services are free, supported by advertisements, in-app purchases, and a subscription tier with perks like an ad- and interruption-free experience.
Revenue jumped by 44% to $126.8 million on a 50% increase in monthly active users (MAUs) to 74.1 million. Duolingo's 5.2 million paid subscribers are only 7% of its total user base. But the platform is becoming big enough to support itself on this small parentage.
Duolingo's size and brand recognizability also give it an economic moat to introduce other synergistic services, such as the Duolingo English test -- a $59 standardized English proficiency test for non-native speakers, accepted at thousands of universities globally.
What could the next few years look like?
Analysts at Global Market Insights expect the global language learning market to expand at a compound annual growth rate (CAGR) of 20% to $337.2 billion by 2032 as global connectivity increases the need for cross-border communication. With a market share of more than 60% among language learning apps, Duolingo is positioned to benefit from the industry's expansion. The company could also leverage new technologies, like generative artificial intelligence (AI), to boost growth.
In March, Duolingo introduced a new subscription tier called Duolingo Max, a step above its regular subscription plan, Super Duolingo. Max gives users all the regular subscription benefits along with AI-powered features, such as Roleplay -- a conversational chatbot with which users can converse in their chosen language.
Image source: Getty Images.
The new tier costs a whopping $30 per month, compared to just $7 for Super Duolingo, highlighting the potential for the company to use technology to boost its growth and monetization potential.
Duolingo's second-quarter adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) grew more than fourfold to $20.9 million on a combination of increasing revenue growth and better margins. Over the coming years, investors should expect healthy bottom-line momentum. As a software company, most costs are fixed, not variable, allowing margins to improve dramatically over time.
What about the valuation?
With a price-to-sales multiple of 15.7, Duolingo stock is quite expensive compared to the S&P 500 average of 2.5. That said, sometimes you get what you pay for in the stock market. And fast-growing companies usually trade for a premium. In Duolingo's case, this premium looks fair because of its convincing drivers for long-term growth and margin improvement.
