Duolingo’s impressive growth momentum will send the stock much higher

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So far, 2024 has been an excellent year for AI stocks. Nvidia, the most celebrated AI name, has surged by 80%, while SuperMicro, another high-profile AI stock, has more than tripled.

A less obvious AI name that is firing on all cylinders is Duolingo ($DUOL), the parent company of the eponymous language-learning app. Despite underperforming against the market this year with only a 3% increase, DUOL has seen a robust 80% rise over the past twelve months.

The stock's rally is poised to continue, driven by the company's outstanding performance on both the top and bottom lines. In the most recent quarter, DUOL exceeded analyst estimates and gave a strong full-year outlook, which sent its stock soaring. Yet, this may just be the beginning. Here’s why.

An Under-the-Radar AI Company

Investors are beginning to recognize that Duolingo is more than a language-learning app; it's an AI powerhouse. DUOL integrates AI across its operations, redefining educational technology's role.

At its core, Duolingo offers users the ability to learn new languages through gamified lessons and activities. However, what sets Duolingo apart is not just its user-friendly interface or its broad selection of languages. It's the sophisticated AI and machine learning algorithms that adapt and personalize the learning experience for each user. By analyzing millions of data points, Duolingo's AI can identify patterns in learning behavior, predict challenges that users might face, and tailor the activities to maximize retention and engagement.

DUOL's exceptional user metrics underscore its AI-driven business model's efficacy. In Q4, the app boasted 26.9 million Daily Active Users (DAUs), a 65% y/y increase. This acceleration from the 63% DAU growth in Q3 signals the success of the company’s AI models in enhancing user engagement.

The company continuously experiments with new AI technologies to enhance its offerings. For instance, it has started to use speech recognition to improve pronunciation lessons, and AI-generated content to expand its library of learning materials. By leveraging AI, DUOL is getting closer to its goal of teaching as well as a human tutor.

Its organic growth demonstrates that users appreciate the learning experience enough to share it. In 2023, the app garnered nearly 3 billion social media impressions, a 170% y/y increase. The iconic Duolingo “ding” featured in “Barbie”, the year’s highest-grossing movie, and the company also won its first Cannes Gold Lion award for the 2022 HBO “House of the Dragon” campaign.

Duolingo is not just revolutionizing language learning but education as a whole, leveraging the power of technology and AI. It has expanded into teaching Math and Music within its main app, potentially positioning Duolingo as an essential family subscription. The adoption of family plan subscriptions, which saw over 100% y/y growth in 2023, underscores this potential.

World-Class Top & Bottom-line Performance

Duolingo's growth is not only rapid but accelerating. In the latest quarter, revenue increased 45% year-over-y/y to $151 million, building on the 43% growth in Q3. This reflects the compounding effect of its data analytics capabilities.

Its AI-driven strategies have led to accelerated user growth and higher conversion rates, fueling revenue growth. The paid subscriber penetration rate as a percentage of Monthly Active Users (MAUs) rose to 8.3%, up 0.5% y/y. Duolingo is not merely expanding its user base but is also converting more users into paid subscribers. Through hundreds of AI-powered A/B tests each quarter, the company continually refines its app, boosting conversions. The increase in the paid subscription penetration rate is a testament to the app's stickiness and the success of the company’s user engagement strategies.

Duolingo's unique position in the online language learning space is due to its viral growth strategy, relying mainly on organic growth and strategic spending to enhance brand awareness. For example, DUOL's first Super Bowl ad went viral this year.

A community-first growth approach allowed DUOL to keep marketing expenses flat year-over-year in Q4, even as revenues soared 45% during the same period. This strategy helped the company increase its adjusted income by 577% y/y to $35 million, demonstrating impressive operating leverage. The Q4 adjusted income margin skyrocketed to 23.3%, up from 5% a year earlier. Likewise, its free cash flow margin jumped to 31.6% in Q4, compared to 10.9% in the same period last year.

What About Valuation

Currently, DUOL ranks among the priciest internet stocks on the market. With a share price around $230, it trades at a PS ratio of 18.6x, a steep multiple. However, as you can see below, DUOL's Price/FCF ratio is on a downward trend due to rapidly increasing cash flow generation.

Focusing on the Price/FCF ratio, DUOL trades at a P/FCF of 65, a premium but justifiable multiple given its financial performance. Assuming a 2024 FCF margin of 27% and a P/FCF ratio of 60, DUOL's stock could rise 20% from current levels to $276 by year-end.

What Else

While Duolingo is seeing accelerated revenue and user growth, this pace is not sustainable, and growth is expected to moderate this year. If growth decelerates more than expected, investors will probably punish the stock. However, even if the company exceeds estimates, the stock may not see significant gains due to its high valuation.

Despite its lofty valuation, DUOL remains an attractive investment at current prices. It stands out as one of the most promising publicly-listed AI names, with strong growth momentum and bright future prospects.

DUOLINGO RATING

Short Term: Buy

Long Term: Buy

🎯 FY2024 Price Target: $276

I’m long DUOL.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.