Duolingo (DUOL +2.73%) stock is down 28% since the company reported third-quarter financial results on Nov. 5, despite exceeding expectations for revenue and subscribers. The stock fell due to soft guidance for the fourth quarter, when the company expects significantly lower growth in bookings.
However, growth in revenue or bookings doesn't tell investors about the real health of the business, which is how well Duolingo is retaining its users. Here's why the stock's recent decline is an excellent opportunity to invest in this growing business at a discount.
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Subscription revenue is growing strong
Duolingo was founded in 2011 by Luis von Ahn, the current CEO, and Severin Hacker. What they have accomplished is impressive. Duolingo started as a language learning app but has expanded its course curriculum to include math, music, and chess. It ended the quarter with 135 million monthly active users, a 20% year-over-year increase.
Generally, there is a time lapse between someone downloading the app and then spending money on it. The company is constantly A/B testing new features to refine the right formula that keeps users satisfied with their experience. This is why it's very encouraging to see that subscription revenue grew 46% year over year to $229 million, indicating high customer satisfaction.
However, investors were more focused on weak guidance for the fourth quarter. After Duolingo reported a 33% year-over-year increase in total bookings in Q3, its Q4 guidance called for bookings to increase just 21.3% to 23.5%. Management stated that the lower guidance reflects its strategy to shift investment toward growing user numbers, rather than maximizing revenue in the near term.
While investors seemed to interpret this decelerating growth as evidence that Duolingo is losing ground to competitors, a closer examination of the earnings report reveals otherwise.
NASDAQ: DUOL
Key Data Points
Why the stock is undervalued
Investors appeared to view the weak guidance as evidence that ChatGPT and other chatbots are taking market share away from Duolingo. But these applications have been around for a few years, and Duolingo continues to retain users, who are increasingly using the app daily.
The number of daily active users increased 36% year over year to reach 50 million, nearly twice the rate of growth in monthly active users, which totaled 135 million. In response to an analyst question about the reason for the weak guidance, Duolingo's CFO Matthew Skaruppa said, "Broader platform retention ... remains strong. No real changes in that."
The only thing that has changed is that the valuation is much more attractive after the stock's collapse. Shares are now trading at a price-to-free-cash-flow multiple of 26, which is a bargain for a company that has grown its trailing-12-month free cash flow by 52% year over year. The stock's recent dip offers a compelling opportunity to start a position in this fast-growing education platform.
