It's been a year of pleasant surprises for Duolingo (DUOL 3.64%) investors. When the company behind the language learning application of the same name announced its third-quarter results, management issued its third set of upward guidance revisions.
Of course, I'm not the first person to notice Duolingo's rapidly improving performance metrics. The stock has risen by around 178% this year.
Is Duolingo still a good stock to buy following its latest rally?
So much better than expected
Duolingo's Q3 report contained this year's third upward guidance revisions for bookings, revenue, and earnings. According to management's new outlook, total bookings for 2023 are expected to land between $598 million and $601 million. The midpoint of that new range would be a 40% gain over 2022.
| Guidance Metric | Q4 2022 | Q1 2023 | Q2 2023 | Q3 2023 |
|---|---|---|---|---|
| Total bookings (midpoint) | $536 million | $557 million | $572 million | $600 million |
| Revenue (midpoint) | $492 million | $505 million | $513 million | $527 million |
| Adjusted EBITDA (midpoint) | $53.7 million | $58 million |
$74.4 million |
$88.2 million |
Source: Duolingo. EBITDA = earnings before interest, taxes, depreciation, and amortization.
Wall Street was expecting a bottom-line loss from Duolingo in Q3, but it delivered positive earnings by generally accepted accounting practices (GAAP). Net income reached $2.8 million compared to an $18.4 million loss in the prior-year period.
There's a good chance that this year's pattern of revenue and earnings growth will continue into 2024. The company reported 24.2 million daily active users during the quarter, up 63% from the prior-year period.
Most Duolingo users aren't paying subscribers, but the company is converting free users at an impressive pace. It ended September with 5.8 million paid subscribers, up 60% year over year and up 164% from the number it had two years earlier.
Earnings growth ahead
Education software sales tend to follow a predictable pattern. Following an initial period of popularity, getting new users on board while maintaining old ones becomes an uphill challenge. That's a challenge Duolingo's competitors never learned to solve.
Duolingo is bucking the trend with innovative marketing activity that has given its brand wide recognition even though it doesn't pay through the nose for advertising. Third-quarter sales and marketing expenses rose just 25% year over year to a very manageable $22.3 million. Thanks to some highly effective social-first marketing efforts, its paid subscriptions over the same time frame rose more than twice as fast.
In addition to a free cameo in the hit Barbie movie, Duolingo's TikTok account has more than 8 million followers. The company regularly draws attention to its brand from millions of potential subscribers with goofy videos that cost next to nothing to produce.
Image source: Getty Images.
Building a moat
Subscribers are flocking to Duolingo now, but success always inspires competition. Now that it's the industry leader, investors should be wondering how long it can fend off competition.
I'd argue that the popularity of Duolingo's constantly improving courses will become increasingly difficult to match. Every day, the company experiments with updated versions of its courses and then measures the effect those changes have on engagement. This means the goal line for potential competitors, which don't have millions of users to run such tests on, keeps getting harder to reach.
With 83.1 million monthly active users spread all over the globe, Duolingo has plenty of avenues for growth. For example, the Duolingo English Test launched in 2016, and it's already a widely accepted mark of proficiency. English test revenue rose 30% year over year in Q3 to $10.6 million. At its present pace of growth, English test revenue will surpass advertising to become the company's second-largest source of revenue in 2024.
Duolingo isn't limiting itself to languages. A little over a year ago, it launched a separate application for math instruction that is now included in its flagship mobile app, along with a new music course.
A buy now
At recent share prices, Duolingo is valued at a sky-high multiple of 18 times sales. The advantages it has over potential competitors could allow its earnings to grow by leaps and bounds for many years, but this outcome is far from guaranteed.
Any signs of a slowdown over the next few years could pull the rug out from under this richly valued growth stock. It's still a good stock to buy, but only for investors who can tolerate a significant level of risk and hold it long term.
