Duolingo (DUOL 3.64%) shareholders have had a lot to smile about over the past 14 months. Since the end of 2022, the stock has risen a spectacular 233%, which has many investors wondering if it's already too late to buy some shares.
Millions of new active users are flocking to the education app and signing up for paid subscriptions. Growth has been outstanding to date, but the company's stock market valuation means it has to continue growing rapidly or investors who buy at recent prices could suffer heavy losses.
Let's weigh the opportunities in front of Duolingo against some challenges it faces to see if it could be a wise addition to most investors' portfolios.
Why Duolingo stock is soaring
Shares of Duolingo recently jumped in response to fourth-quarter earnings results that blew way past expectations. The average analyst expected fourth-quarter earnings to reach $0.17 per share. The market was pleasantly surprised by earnings that reached $0.26 per share.
Sales also exceeded expectations, driven by a user base that keeps defying gravity. The number of daily active users on the Duolingo app soared 65% year over year to 26.9 million, and many pay for premium subscriptions. Subscription bookings soared 49% last year to $495 million.
Why Duolingo could be a great stock to buy and hold
It isn't so unusual for new education applications to gain popularity. Unfortunately, bringing in a steady influx of new users to replace those who leave tends to grow more expensive until these operations implode.
You may remember Rosetta Stone went public in 2009, only to be taken private again in 2020. In 2019, its last year as a publicly traded company, Rosetta Stone plowed an unsustainable 68% of its gross profit into sales and marketing. Despite the heavy marketing investment, revenue increased just 5% that year.
Comparing Duolingo's recent performance to Rosetta Stone's shows us that the big green owl is a completely different animal. In 2023, the company spent just 19% of its gross profit on sales and marketing expenses. Despite the modest marketing investment, revenue rose 44% last year.
Duolingo's efficient marketing tactics include a TikTok account that regularly draws millions of eyes to its big green mascot. Altogether, the company's social-first marketing strategy racked up nearly 3 billion media impressions last year, which was 170% more than in 2022. Spending on sales and marketing rose just 13% last year.
DUOL Revenue (TTM) data by YCharts
The area where Duolingo isn't holding back is research and development. They can't all be zingers, but new lessons that turn subscribers away don't last long. Every day the Duolingo app shows a handful of users new refinements that the rest of its user base doesn't see unless test subjects find them engaging.
With 26.9 million daily active users and 88.4 million monthly active users at the end of 2023, Duolingo has far more insight into what works on a smartphone than any of its competitors. This advantage probably won't last forever, but we can reasonably expect retention to remain strong for at least another five years.
Reasons to remain cautious
Duolingo's stock price soared for good reasons, but expectations are so high now that the stock might be riskier than some investors realize. Its shares have been trading for about 71 times forward-looking earnings estimates, or 20.2 times trailing sales. That means an investment in the company now isn't going to work out unless its rapid growth rate continues for at least a few more years.
Duolingo is already forecasting a slowdown. Bookings soared 45% in 2023. Management expects bookings to grow between 27% and 29% this year.
If management had predicted another year of bookings growth above 40%, buying the stock now in the hope it can grow past a high valuation would make sense. For now, it's probably best to keep this stock on a watchlist.
