If you're confused by Duolingo's (DUOL -1.88%) recent stock market performance, you're not alone. Plenty of investors are shaking their heads after watching its stock price tank by 18% on May 9, the day after it reported record-breaking quarterly earnings.
Duolingo's reported results from the first quarter suggest its education application of the same name is gaining popularity at a mind-bending pace. The company even raised its outlook for the rest of 2024.
From the beginning of 2023 through May 8, 2024, Duolingo stock put up a huge 244% gain. If you missed out on the big run-up, a recent mismatch between the performances of Duolingo's operation and its stock price could make now a good time to buy.
Let's take a closer look to see if this is a good stock for growth-seeking investors to buy on the dip.
Why Duolingo stock is down
Duolingo's big run-up probably ran a little too far. When the company reported first-quarter results, its shares were trading for more than 66 times forward earnings expectations.
When you see earnings multiples as high as Duolingo's it usually means the market has high expectations. The stock tanked because daily active user growth decelerated slightly from a 65% year-to-year gain in the fourth quarter of 2023 to a 54% year-to-year gain in the first quarter of 2024. The company also reported paid subscription growth that decelerated from 57% year over year in the last three months of 2023 to 54% in the first quarter of this year.
Following Duolingo's fourth-quarter report in February, we knew that expecting its amazing growth rates to continue was unreasonable, but the stock market pushed the stock higher anyway.
The good news for Duolingo
A 54% year-over-year growth rate is still amazing for a company as well established as Duolingo. Viewed from another angle, it added 4.5 million daily active users during the first three months of 2024. That was 1.8 million more than it added during the last three months of 2023.
Duolingo's ability to convert free users to paid subscribers is more than encouraging. Duolingo finished the first quarter with 7.4 million paid subscribers, which was 54% more than it had a year earlier. That was a slight deceleration compared to fourth-quarter subscriber growth, but only by a few percentage points.
| Performance Indicator | Q1 2024 | YoY Gain | Q4 2024 | YoY Gain |
|---|---|---|---|---|
| Daily active users | 31.4 million | 54% | 26.9 million | 65% |
| Paid subscribers | 7.4 million | 54% | 6.6 million | 57% |
| Total bookings | $197.5 million | 41% | $191 million | 51% |
| Free cash flow | $79.6 million | 176% | $47.7 million |
322% |
Q1 = First quarter; YoY =Year over year; Data source: Duolingo.
Duolingo is becoming a well-recognized brand around the world without a big advertising investment. First-quarter sales and marketing expenses rose just 20% year over year.
A subscription service that seems to sell itself is pushing up profitability. Duolingo's adjusted EBITDA margin more than doubled to 26.3% during the first quarter. Free cash flow rose to $79.6 million in the first quarter, or a very healthy 48% of total revenue during the period.
A buy on the dip?
Strong profit margins are a sign that Duolingo has a competitive advantage in the education software industry. The company constantly introduces new lessons to a limited audience and carefully measures engagement levels before rolling out improvements to all of its users. It's still too early to be certain, but I think Duolingo's collection of finely tuned lessons is a durable advantage that smaller competitors aren't likely to replicate.
The company's impressive growth rates can't continue forever. With a durable competitive advantage, though, expecting annual growth at a low double-digit percentage over the next decade isn't unreasonable.
At recent prices, the stock is trading for about 27 times annualized first-quarter free cash flow. That's a reasonable price to pay for shares of a profitable business that's growing by leaps and bounds. Even if we factor in continued deceleration, the stock looks like a smart buy on the dip for most growth-seeking investors.
