2024-01-03 05:29:39 ET
Summary
- Duolingo is a founder-led education company that offers language learning courses and has expanded into math and music.
- The company's focus on experimentation, robust testing and emphasize on AI has created a moat and first mover advantage.
- Duolingo's Q3 2023 financial results were impressive as growing users have led to increased revenues and finally profitable. However, these results have led to an unjustifiable stock price.
2023 was a year full of surprises. 2023 established the "Magnificent Seven", saw banks such as Silicon Valley Bank collapse, while interest rates continued to climb at a historic pace.
As an investor, I also experienced some surprises in my own portfolio. Today, I'd like to discuss one my stocks which is a founder-led company which excelled in 2023 as it beat the S&P 500 and grew by over 200%.
That company is Duolingo (DUOL). Let's dig in the company, recent financials, and why I think this company will continue to a winner in the years to come.
The Company
Duolingo is a technology and education company, and their mission is to develop the best education in the world and make it universally available. Many people may be familiar with Duolingo as it is a popular app which has helped various individuals all across the globe learn a new language. Duolingo is currently the world's most popular education app and as of the company's last annual filing, Duolingo offered courses in over 40 languages to more than 60 million monthly active units.
Duolingo has also branched out into math and music in addition to creating an app for children (Duolingo ABC) which helps them learn to read. My children use this app and it's been a great way for them to learn new letters while letting them have fun.
Duolingo was founded back in 2011 by Luis von Ahn and Severin Hacker and the company went public in 2021. Both of which are still with the company. The duo have created a fun way to engage users through gamification as more and more users are downloading Duolingo.
Moat and Opportunity
According to the company's latest annual filing , Duolingo believes there is a $60 billion dollar market opportunity as according to HolonIQ, roughly two billion people across the globe are learning a new language.
That's just the language side of the business. As noted above, Duolingo has recently entered into math as well as music. One reason, I like this business is the potential to enter other spaces.
I do think Duolingo has a moat, and Von Ahn stated the same on the company's Q3 earnings webcast , " We have a strong belief that the hardest thing about learning a language is staying motivated. And that is something that we really excel at."
In the United States, before Duolingo 80% of users weren't learning a new language which I think really speaks to the way Duolingo has created a fun, easy, engaging app. The streak feature was an incredible idea and one that keep users on the app as individuals want to maintain their streaks.
Duolingo has a first mover advantage as well. Some many argue Babble and Rosetta Stone are as competitive, but I don't believe that is the case. I think Duolingo really emphasized AI and gamification first. In listening to prior earnings calls, human interaction such as one-on-one tutoring was never the plan. Duolingo wanted to create an exciting, engaging app that is continuously adapting and improving. As noted on the company's latest shareholder letter , Duolingo has a culture of experimentation and continuously testing. The results speak for themselves as this experimentation has led to progress in user engagement, learning outcomes and financial progress (which I'll discuss in more depth below).
These Q3 2023 user metrics clearly illustrate how Duolingo has been able to enhance their app and growth active users and subscribers:
Q3 2023 shareholder letter
Duolingo also more data compared to their peers. Roughly 10 billion exercises are completed by Duolingo users in a single week, so the company has more data on language learning than their competitors. This is certainly a competitive advantage and paired with the company's robust testing and experimentation it's difficult to see a rival overtaking Duolingo in the near future.
Management
Luis von Ahn is the current CEO of Duolingo and as noted above is one of the company's co-founders . Von Ahn has an impressive background as he invented and was the previous CEO of reCAPTCHA before it was acquired by Google in 2009.
Severin Hacker is Duolingo's other co-founder and is the current Chief Technology Officer.
Matthew Skaruppa is the company's Chief Financial Officer. Skaruppa previously worked at Goldman Sachs prior to working at Duolingo.
As you can see below by the Glassdoor reviews, Duolingo is viewed as an excellent place to work and the company's employees clearly approve of the job Von Ahn is doing:
Glassdoor
Financials
Duolingo's Q3 2023 results were stellar as the company is now turning a profit and is generating more free cash flow.
Total revenues for Q3 2023 were roughly $137 million dollars which is an increase of 43% compared to prior year quarter. Total bookings were roughly $153 million which is an increase of 49% compared to Q3 2022. Subscription bookings were approximately $121 million which is an increase of 60% compared to prior year third quarter.
The company did post net income of over $2.8 million for the current quarter as you can see below:
SEC.gov
The company's interest income of over $8 million helped them get there for the quarter. Nonetheless, the turn to profitability given the considerable loss in Q3 2022 is impressive.
Furthermore, Duolingo has an excellent balance sheet as you can see below:
Sec.gov
The company has a sizeable cash balance which covers all of company's liabilities. Duolingo has no long-term debt and most of the company's liabilities are comprising of deferred revenue.
The company's financial progress is impressive and it indicates Duolingo's model is working as their culture of testing and experimentation coupled with AI is generating a top-notch user experience driving growth.
Risks
Duolingo lists numerous risks to the business on their annual report . I'm going to discuss three risks which I believe could hurt the organization.
In the short term, if macroeconomic conditions worsen and the United States enters into a recession consumer discretionary spending will surely be impacted. Duolingo has done a stellar job of monetizing user growth, but I find it unlikely as many users will upgrade to being a paying user if such macroeconomic conditions arise.
As I mentioned above, I believe Duolingo has a moat but given the rise of AI a competitor may be able to catch up to Duolingo. On the company's most recent earnings call Von Ahn noted he didn't view Google as a threat however Google and Microsoft have the resources to allocate significant funds into AI. I don't personally see either making a sizable effort to enter this market, but Google has allocated funds to "other bets" so only time will tell if language learning could become one of those bets.
Finally, there's risk entry into Math and/or Music could flop. I think the company will be successful in expanding into these new areas however should Duolingo fail, users won't be as likely to test new offerings and it could impact the company's ability to expand beyond language learning.
Valuation
As you can see from the below valuation metrics from Seeking Alpha, the overall value grade for Duolingo is a "F."
It's tough to justify this valuation as you can see Duolingo far surpasses the sector medians for all the metrics noted above.
If the company's forward P/E ratio dropped back to below at least 60 as it did in September of 2023, I'd be a buyer around that $150 price point.
As much as I like this company, I can't recommend investors buy shares given the current valuation.
Conclusion
Duolingo is an impressive founder-led company with a wonderful mission of developing a world-class educational app and making it universally available. The organization's culture and focus on AI has given Duolingo a moat and first mover advantage within the language learning marketplace.
Duolingo is thriving as their user metrics illustrate and this user growth is leading to monetization and profitability.
However, the company's valuation is outrageous as the stock has grown tremendously over the last year.
I'll be looking to add shares once the stock price drops back to levels experienced back in late summer as I think this is a wonderful business.
For further details see:
Duolingo: Outstanding Business With Outrageous Valuation