I’m wondering what to buy next for my Stocks and Shares ISA. Wall Street legend Peter Lynch advocated the “buy what you know” principle. This encourages investors to focus on firms that they are familiar with, as this understanding can lead to fruitful investment opportunities.
So I’ve been considering shares of Duolingo (NASDAQ: DUOL). This is the world’s largest language learning app, providing courses for 42 languages and a stand-alone English proficiency test.
Employing an ad-supported freemium model, it has grown its monthly active users from 50m in 2022 to 103m today. In Q2, the number of premium users subscribing to unlock additional features surged 52% year on year, reaching 8m.
I’m one of those paying subscribers. The big green Duolingo owl is on my case daily, pestering me to practice my Spanish on the gamified app. As such, it has a prominent place on my phone’s home screen, next to Spotify, YouTube and Amazon‘s Audible. Not bad company!
But does my familiarity with Duolingo mean I should buy the stock at $278? ¡Vamos a ver! (Let’s see!).
Rapid profitable growth
The stock has surged 67% in one year, and the reasons are clear. Revenue increased by 44% last year to reach $531m. This year, revenue is projected to grow another 39% to $736m, while adjusted EBITDA is expected to nearly double, reaching around $180m. That’s impressive growth.
Looking forward to 2026, analysts have $1.2bn in revenue pencilled in, more than doubling from last year. Free cash flow is expected to be $425m by then, which would translate into a cash-based profit margin of 35%.
Using AI
Duolingo has launched a new premium subscription tier called Max. It offers two AI-powered features: Explain My Answer, which gives personalised feedback on mistakes, and Roleplay, which allows learners to practice conversational skills with characters in the app. Both run on OpenAI’s GPT-4 models.
Personally, I’m not upgrading to Duolingo Max, but it could be another driver of growth moving forward.
My worry, though, is that language learners might start using free AI chatbots for many of the features that Duolingo charges for. These models are increasingly powerful and could one day disrupt many business models, including language learning apps.
ChatGPT has already inspired a collapse in the share price of Chegg, another online education firm (focused on homework help). I doubt it’ll be the last.
I’m interested
Despite these reservations, Duolingo is clearly pursuing a massive market opportunity. Over two billion people in the world are learning a foreign language, and much of this is shifting online.
Meanwhile, most Duolingo users sign up through word of mouth, resulting in less marketing spend. And just 8.6% of monthly active users are currently paying subscribers.
The founder-CEO is Luis von Ahn, a former professor of computer science who co-invented CAPTCHAs. He has said: “Over the long term, the hope is that Duolingo gets known, not just as a language learning app, but also as an app where you can learn math and music.”
This highlights the potential for Duolingo to become an education super-app. Its long-term goal is to teach as well as a human tutor.
However, the shares aren’t cheap at 16.5 times forward sales. I want to invest, but I’ll wait for a better entry point.
