Duolingo Stock Is Fun - As Is The App
This post is an update of a post first published on 05/11/2023. It was expanded and updated after the announcement of the Duolingo Q2 2023 financial results.
At the end of 2022 I had the Duolingo Investmentstory presented. If you haven't heard of the Duolingo stock or the Duolingo app for language learning, then I recommend reading this initial post here. At that point, the share price was just over $70, well below the initial offering price of $102 at the time of the IPO in mid-2021.
That's long gone. Because since the beginning of 2023, the Duolingo share has risen by more than 100% from its low.
This price increase is fundamentally well justified. Because excellent figures for 2022 were followed by two outstanding quarterly reports for the first half of 2023. And then there is the upcoming roll-out of a new AI-based product as well as rumors about other products that offer a lot of imagination for the longer term (more on that later).
Duolingo in practice
Before I analyze the current Duolingo numbers, a little reference to the internal Duolingo mania at my family: As is so often the case when investing in a consumer product, I tried the Duolingo product myself in the past few quarters.
After months of sporadic use of the free version, the Duolingo in-app ads annoyed me so much that I switched to the paid version. For a small additional fee, I got a few more licenses that I gave out to family members.
And that's when the Duolingo gamification unfolded its magic: Today, 4 family members (including my over 80-year-old mom) do their Duolingo lessons in 3 different foreign languages every day and remind each other of their regular exercises in a funny way.
The app is addictive - and in this case that's a positive thing!
Interestingly, older users actually use Duolingo much more regularly than younger users. Who would have thought?
After this user experience, it becomes clear to me why Duolingo does not have a problem with excessive churn, as some critical analysts feared after the IPO. At least in our family, Duolingo has become indispensable.
The Duolingo figures for Q2 2023
Duolingo has once again delivered an impressive result with its Q2 2023 figures and significantly exceeded expectations.
Revenue increased by 44% yoy to $127m in Q2 2023, bookings advanced by +41% to $137.5m.
It is interesting that the in-app purchases within the Duolingo app are currently growing in the triple digits and now account for 7% of sales. It looks as if they could establish another quite important revenue stream here in addition to the subscriptions, the advertising-financed freemium version and the English tests:
Duolingo revenue mix Q2 2023
Improving profitability is at least as important to growth investors in these times as top-line growth.
I hardly know of any company with such good operational leverage as Duolingo, i.e. the rapid growth in sales translates very nicely into an increase in operating profit. The reason for this is that the expense ratios for sales+marketing (S&M) as well as for general administration (G&A) are declining rapidly: I hardly know of such a fast-growing B2C company that spends only 14% of sales (according to GAAP) on sales and marketing.
The reason is that the Duolingo app is spreading virally like wildfire in many different countries with efficient social media support.
Duolingo continues to spend a lot of money on the further development of the product portfolio. At 38% of sales, the corresponding R&D cost ratio (research+development) is almost twice as high as the average for the software companies I have observed.
So Duolingo could always be much more profitable than it is today if it decided to scale back those investments to normal levels in the future.
But they don't have to: The free cash flow margin rose from 11% to 27% within one year in Q2 2023. Bravo!
The bottom line for Q2 2023 is a net profit of $3.7 million for the first time, even according to GAAP, after a loss of $15 million in the same period last year. Here, too, there is impressive operational leverage!
Cash on the clean balance sheet has grown from $608 million to $677 million over the last 6 months.
It is remarkable that Duolingo's cash holdings have continued to grow quarter by quarter since the IPO in summer 2021. It almost seems as if the founders are Luis von Ahn (CEO) and Severin Hacker (CTO ) surprised themselves by the viral success of their app: Because they haven't needed the $500 million in equity from the IPO to advance Duolingo to this day.
The secret of this success ultimately lies in the extremely efficient user growth: In Q2 2023, DAUs (daily active users) increased by 62% year-on-year to 21.4 million and paying customers by 59%, while sales and Marketing spend (non-GAAP) increased just 13%!
So Duolingo seems to be one of those companies that is currently immune to the weak economy.
The Duolingo Guidance for 2023
With the presentation of the Q2 figures, Duolingo has significantly increased its initially very conservative guidance for the second time this year. Sales are now expected to increase by at least 38% to over $510 million in 2023. This requires an increase in bookings of around 33%. The EBITDA margin should increase from 4% to at least 14% (Non-GAAP).
There is some evidence that this raised outlook is still too conservative. Because both the development of the number of paying users and the commitment of users to the Duolingo apps overall indicate continued rapid organic growth in the second half of 2023.
As a reminder, Duolingo initially forecast sales growth of 32-36% for 2022. After several beat+raise quarters, they finally ended up with 47% growth!
Personally, I expect a clear outperformance compared to this guidance and after this Q2 I expect sales growth for 2023 of well over 40% again.
Duolingo shares in the AI hype
Duolingo has been in partnership with OpenAI since 2021, whose AI technologies (Artificial Intelligence) are experiencing a meteoric rise, especially due to the hype surrounding the chatbot ChatGPT.
Specifically, based on the OpenAI language generation capabilities, Duolingo is developing a new product called Duolingo Max, which goes far beyond the base of the current Duolingo app, which is designed for beginners to learn a new language.
With the help of AI, Duolingo Max - at a higher price - will soon also provide advanced English learners with a language assistant that comes as close as possible to a human English teacher.
The Duolingo management has repeatedly emphasized that this upcoming AI product will be irrelevant for sales in 2023 and that they will take their time with the introduction to the market. But it does currently play a role in the development of the share price. Because it fuels the AI hype.
But that also means for me: caution is the order of the day here and we have to keep an eye on the valuation of the Duolingo share.
New products: Duolingo Math and Duolingo Music
Duolingo's mission statement is very self-confident:
Our mission is to develop the best education in the world and make it universally available."
Although according to the company, the TAM for learning foreign languages alone is $60 billion, Duolingo is already working intensively on other education apps.
Duolingo Math is an App for practicing math tasks which is available for free in the AppStore. So far, the app has primarily been intended to practice math in a playful way with children of primary school age.
Monetization of Duolingo Math is not planned in the short term. They want to repeat the successful Duolingo Playbook, which first of all aims to win a large user base for a free product.
Another product launch could be forthcoming with Duolingo Music. In March 2023, TechCrunch speculated about it due to Duolingo job postings.
Now there were Notices in the Duolingo app (Code fragments, images) that point to a music product for learning instruments (piano, drums?) and/or music theory. It remains exciting.
The valuation of the Duolingo stock
After the price explosion in the course of the year so far, Duolingos Enterprise Value (here simply explained) stands at $5.5 billion. This corresponds to an almost double-digit EV/Sales (2023) ratio.
From now on you can also rate Duolingo on the basis of cash flow multiples. I'm estimating free cash flow at $100-120m, so that would be an EV/FCF ratio of 50.
After the fundamentally justified price increase, that's a sporty price, but it's still quite fair - if you take into account the great growth dynamic and the high operational leverage.
I will continue to hold my position until further notice. Because Duolingo has what it takes to quickly get into this evaluation and then grow significantly beyond it.
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Disclaimer
The author and/or related persons or companies own shares in Duolingo. This article is an expression of opinion and not investment advice. Please note the Legal Notice.
