Stock prices go up, and stock prices go down. Tell me you found a stock that always goes in one direction, without even the slightest bump along the way, and I'll politely decline buying that cool bridge you have for sale. It just doesn't work that way. But in the long run, good businesses almost inevitably deliver strong stock returns while the lesser lights fade out.
Wall Street is always a bumpy road, and the temporary downticks for potential long-term winners can be great buy-in opportunities. That's what I see in language-learning specialist Duolingo (DUOL 3.64%) right now.
Here's why you should consider adding some Duolingo stock to your portfolio while it's down 28% from its all-time highs.
Decoding Duolingo's valuation
Long story short -- I don't think Duolingo will be cheap for long.
OK, I see you laughing. Duolingo's shares trade at the hefty valuation ratios of 17 times sales and 93 times forward earnings. Sorry if you did a spit-take with your coffee when I called it "cheap."
But we could have had a similar discussion about Amazon (NASDAQ: AMZN) in the 1990s, or Monster Beverage (NASDAQ: MNST) (Hansen Natural back then) 10 years later. Yes, growth stocks can be risky and many never live up to their early promises, but some are headed toward market-crushing success in the long run. Both Amazon and Monster have obliterated the broader stock market's returns over the last two decades. The S&P 500 (SNPINDEX: ^GSPC) index more than quadrupled over this period, but that looks like a flat line by comparison.
Past performance is no guarantee of future returns, and I'm comparing Duolingo to some of the biggest long-term winners on the market. But I think Duolingo deserves a chair at this stellar table, because these companies' growth-optimizing business plans have so much in common.
Strategic moves ahead
So Duolingo's lofty valuation doesn't scare me. I realize that value-investing geniuses like Warren Buffett wouldn't touch this stock with a 10-foot English-to-Spanish dictionary, but we work with different investing styles.
If you see a mature language-learning expert in Duolingo, with every reachable branch stripped clean of low-hanging growth fruit, you're missing the big picture. This growth story is just getting started.
Duolingo's business is growing like the out-of-control weeds in the backyard. In November's third-quarter report, for example, revenues rose 43% year over year. At the same time, bookings of premium service subscriptions increased by 54%, and the number of paid users jumped 60% higher. Daily active users (DAUs) delivered the strongest growth of all, notching a year-over-year gain of 63%.
Just like Amazon and Monster Beverage in their respective high-growth heydays, Duolingo supports its lofty stock price with a soaring growth trend. The company is building a large user base for a more lucrative future.
Duolingo's innovative path to higher profits
The company can pull many levers to achieve higher profits when the current hypergrowth phase is over:
- Large addressable market: Language learning is a huge global industry, worth over $50 billion annually with double-digit annual percentage growth expected over the next decade. As Duolingo expands the number of languages offered and reaches more geographies, there is significant room for user growth. And beyond that, the recently launched music and math courses look like harbingers of many more fields of study -- boosting the potential target market even further.
- Sticky retention: Duolingo has developed an engaging, game-like interface that encourages users to come back regularly. My streak of daily work on many different languages stands at 2,796 days now -- how's yours? This game-like experience leads to strong retention rates and greater opportunities to monetize over time. Robust user engagement should lead to a rock-solid business for years to come.
- Monetization opportunities: While Duolingo is currently intensely focused on user growth, there are several ways it could monetize in the future. Premium subscriptions are a good start, perhaps followed by corporate training programs, test prep services, and more. Less than 2% of users currently pay, leaving room to increase monetization in the existing user cohort.
- Brand recognition and leadership: Duolingo is a recognized leader in the digital language learning space. Duolingo is well positioned to capitalize as the category continues to move online, given its first-mover advantage, scale, and brand reputation. Expanding this market-defining reputation into other topics of study makes perfect sense.
- Global expansion: Most current users are English speakers learning a second language. In addition to launching new languages, Duolingo also has opportunities to increase penetration in non-English-speaking countries around the world.
While not without risks from its high valuation and artificial intelligence (AI)-based competition, Duolingo's platform, deeply engaged user base, and unrealized monetization opportunities suggest sustainable long-term growth if the company plays its cards right. Continued product innovation and global expansion will be key, and I'm quite excited about new options such as math and music.
It's time to invest in Duolingo's digital learning revolution
Duolingo may not be cheap in the classical sense, but it's still a deal in my eyes when the stock trades 28% below a recent peak. I can't promise that investing in Duolingo today will be as rewarding as Amazon stock in 1995 or Monster Beverage in 2005 -- but the company is treading a similar path. Amazon essentially built the e-commerce industry many years ago, Monster pulled the energy drink market up by the bootstraps, and Duolingo is transforming the digital learning sector.
I can't wait to see how far Duolingo will go under the brilliant and ambitious leadership of CEO, co-founder, and MacArthur Fellow Luis von Ahn. The whole world is going digital, and Duolingo is ready to lead the way. This little online learning expert is going places.
