Duolingo: The Post-Earnings Crash Makes This Stock More Appealing (NASDAQ:DUOL) (2024)

Duolingo (NASDAQ:DUOL), the language learning app used by more than 20 million daily users, is proof that the current earnings cycle is incredibly volatile. Despite a “beat and raise” quarter that beat expectations on the top and bottom line while also raising bookings and profit expectations for the year, Duolingo had one of its biggest one-day tumbles on record, falling nearly 20% post-earnings.

The drop has washed out all of Duolingo’s year-to-date gains, and the stock is now sitting at down 5% for the year.

At a slightly cheaper price, Duolingo is becoming more and more appealing

Duolingo’s tumble, of course, is a reflection of its high valuation: which I pointed out as one of the stock’s core flaws in my last article on it in March, when Duolingo was trading closer to $230 per share. Arguably, this tumble still doesn’t do enough to bring Duolingo’s valuation multiples back down to earth: but it does push Duolingo closer into what I’d consider a more confident buying territory.

I upgraded Duolingo to a neutral rating in March. I am still neutral on the stock today (even after the drop, valuation gives me some jitters): but I am far more constructive about Duolingo’s prospects after the surprising earnings drop.

There are a number of reasons to remain bullish on Duolingo. First: the world’s population of aspiring language learners is continuing to grow. Travel demand is part of this, as post-COVID travel has remained red-hot and inspired many people to pick up new languages. General language proficiency is another key driver, especially as Duolingo rolls out its English testing and certification products.

Second: the company is continuing to innovate. Duolingo Max, its highest-tier subscription plan, is among the more exciting Duolingo releases that incorporates AI-based chat and conversation into a user’s daily language practice. The company also continues to lean in on its Family Plan offering, which encourages users to build a pool of family users to share a paid Duolingo experience and increase the company’s overall DAUs and MAUs. And of course, Duolingo is also continuing to expand its offerings beyond languages, having already charted a plan to build out its music and math courses with plans to add additional subjects in the future.

There are, of course, risks that balance out these opportunities. Competition is one: while Duolingo is certainly popular and growing like a weed, it’s not the only language-learning platform out there, with longtime program Rosetta Stone remains popular alongside newer entrants like Babbel. Second, as more and more consumers become budget-conscious and review their subscription spending, there’s certainly a risk that Duolingo will see higher churn (which the company is trying to offset by emphasizing annual over monthly plans, at a discount).

The biggest risk to Duolingo, however, is still its expensive valuation. At current share prices hovering just below $200, Duolingo trades at a $8.60 billion market cap. After we net off the $829.7 million of cash on Duolingo’s most recent balance sheet, the company’s resulting enterprise value is $7.77 billion.

The company has raised its guidance outlook to $725.5-$735.5 million (37-38% y/y) in revenue, which is a two-point increase in growth at the midpoint of the range. It has also bumped up its adjusted EBITDA forecast to a midpoint margin of 23.5%, 150bps better than the prior midpoint of 22.0%.

Still, even against this raised outlook, we find it difficult to justify Duolingo’s valuation:

• 10.6x FY24 revenue
• 45x EV/FY24 adjusted EBITDA

Note that next year, Wall Street analysts are currently expecting Duolingo’s growth to decelerate to 27% y/y to $924 million, against which the stock trades at a 8.3x EV/FY25 revenue multiple.

Personally, I view this to still be expensive, but closer to where I’d be comfortable. I’d move to a solid buy rating on Duolingo at $168, which represents 15% downside to current levels and a ~7x EV/FY25 revenue valuation. At current share prices, I’m comfortable taking a smaller test position, but a bigger buy should wait until Duolingo drops further.

Q1 download

Let’s now go through Duolingo’s latest quarterly results in greater detail. The Q1 earnings summary is shown below:

Duolingo’s revenue grew 45% y/y to $167.6 million in the quarter, slightly ahead of Wall Street’s expectations of $165.7 million (+43% y/y) by a two-point margin. Growth managed to hold pace exactly to Q4’s 45% y/y growth rate, though consensus is expecting revenue to decelerate to 40% y/y by Q2.

Meanwhile, the company added 0.6 million net-new paid subscribers to end Q1 with 4.8 million subscribers, up 54% y/y (versus 57% y/y growth in Q4). Daily active users also rose 54% y/y to 20.3 million, while the DAU to MAU (monthly active user) ratio improved to an all-time high of 32% (versus 28% in the prior-year Q4).

An important growth lever for Duolingo: the company is more aggressively rolling out its highest subscription tier, Duolingo Max (which, as previously mentioned, includes AI conversation capabilities). Per CEO Luis Von Ahn’s remarks on the Q&A portion of the Q2 earnings call:

So we started experimenting with Duolingo Max, which had a couple of AI features, which are mainly conversational features.

And as we said, it was going to take us about a year to get to a wider rollout. And this is what just happened. We started a wider rollout because we're pretty happy with the results. I mean, generally, we're seeing that users that there's a desire from users to have a higher tier. What you'll see us do over the next few quarters is, first of all, roll it, roll out Max to other countries and other languages. Right now, Duolingo Max is accessible only to people who are learning French and Spanish on iOS in six countries. We expect to put it on Android and in many more countries and in many more languages to learn, which will get it to a higher fraction of the use.

The other thing that you'll see us do is we'll see us start shifting features around to see what is the best packaging. And there's no real reason for the highest package to be just AI features. So we're doing experiments, for example, to put unlimited hearts, which, hearts, you lose a heart every time you make a mistake. We're running an experiment to put unlimited hearts in Max. So what you'll see happen is that, by towards the end of the year, we'll probably have a pretty set of features. And then at that time, there will be work to be done to try to move as many of our subscribers to Max as possible.”

Growing subscribers as well as ARPU, which Duolingo Max is intended to do, will be core for the company to continue its aggressive growth path.

Adjusted EBITDA margins in the first quarter also leaped to 26.3%, versus just 13.1% in the year-ago Q1, while nominal adjusted EBITDA dollars nearly tripled to $44.0 million. This was driven primarily by a ten-point reduction in sales and marketing costs, and a five-point reduction in G&A costs, as a percentage of revenue.

Key takeaways

It's still too early to justify Duolingo's valuation from a profitability standpoint, but with the post-earnings crash, Duolingo's stock is starting to look more palatable against FY25 revenue, especially considering the company is still growing paid subscribers at a +50% rate, with a potential further upside catalyst from broader Duolingo Max expansion. I wouldn't put in a large bet just yet, but keep watching this stock closely.

Gary Alexander