Is Duolingo Stock Overvalued?

Duolingo Inc (NASDAQ:DUOL) is an education tech company with over 100 online classes in 40 languages. The company grew to over 500 million downloads and continues to generate larger revenues.

Of course, that growth is slowing as it reaches full market penetration, so is Duolingo stock overvalued?

DUOL share price has been turbulent since its July IPO. Global travel restrictions sparked a shift toward online learning, which was a big boon for the company. However, a return to a normal economy could leave the company with shrinking revenues.

Here’s the skinny on the company.

Duolingo 101

Duolingo is a language learning website and app that provides lessons and proficiency exams. It was created in 2009 by Carnegie Mellon University student Severin Hacker and Luis von Ah, his professor, after selling his company reCAPTCHA to Google.

Each man came to the U.S. from a foreign country with aims to bring free educational resources to the world. They understood the necessity of learning to speak and read different languages and used several academic grants to fund the company at inception.

It provides learning courses and English-language proficiency exams that generate revenue. These e-learning courses are consistently rated among the best software for learning new languages. They are comparable to Rosetta Stone and better rated than Pimsleur and Living Language.

Why Is Duolingo Stock So High?

Duolingo largely remained above its IPO pricing in the intervening months. The company is valued at around $7 billion, and it’s trading at about 20 times trailing 12-month sales. That’s a high price to pay for bears who don’t believe the company has growth potential.

The Pittsburg, Pennsylvania-based app launched in 2012 and quickly became the market leader. It still maintains this position as one of the top-grossing education apps in both mobile app stores.

And it showed impressive growth in its most recent quarter, with a 30 percent year-over-year increase in total bookings and a 47 percent increase in revenues from the prior year. This helped propel the stock higher, but some worry that it may have grown too large to continue this level of growth.

Defining the Business of Language

Language is a cornerstone of the human condition and society, as it’s how we communicate with each other and share information and ideas. It’s also important to understand other languages so we can relate to other cultures and successfully operate in business and politics.

This need created a global language services industry that grew to an estimated $56.18 billion this year. And software related to it is expected to grow to $25 billion in the next two years as part of the greater education software market expected to reach $67.36 billion by 2026.  

Duolingo is a major player in this space, and it continues to grow its user base, which now has nearly 40 million users. Understanding how it monetizes these users is necessary for investors looking for profitable returns, so its business model needs to be examined.

How Duolingo Makes Money

Duolingo uses a freemium business model across both its mobile app and website. It uses ads to monetize free users, while Duolingo Plus users pay from $6.99-$12.99 per month ($83.88-$155.88 per year).

The company generated over $161 million in revenues last year, and about 73 percent came from subscriptions, with 17 percent from ads. The bulk of its revenue comes from the U.S., but Duolingo is expanding overseas, especially in Asian markets.

It has about 2 million paid subscribers, a number that consistently grew over the past two years from 900,000 users in 2019. The lockdowns really accelerated the company’s growth as customer attention migrated to self-improvement apps.

Of course, those gains aren’t guaranteed to continue as the economy returns to normal. And it pays a hefty fee for its mobile app store listings.

Duolingo GAAP Losses A Concern

Despite its revenue growth, Duolingo is still not profitable on a GAAP basis. It clocked eight-figure losses in each of the past two years, and this year isn’t much better. And its monthly active users (MAUs) dropped off in the second quarter at 37.9 million, compared to 39.9 million MAUs in the first quarter.

This decline caused a short selloff as bearish investors feel it may have peaked. It didn’t help that employees were allowed to sell stock immediately after the IPO, which could be a red flag for investors.

Still, it has $115 million on hand despite paying large cuts to Apple (NASDAQ:AAPL) and Alphabet’s (NASDAQ:GOOG) mobile stores. That immediately loses 30 percent in the first year of a subscription and 15 percent in subsequent years.

Much of its revenue is spent on research and development, which it will need to expand in countries like China, where it was suspended over the summer during the country’s app crackdown.

Is Duolingo Stock Overvalued? The Bottom Line

Duolingo is a language learning platform for web and mobile that’s highly rated by critics. However, investors are split on the red flags, like a slowing user base and inability to turn a profit.

Still, the company has high hopes that if it can find ways to cover its overhead. And it’s going to need to focus heavily on regaining traction in markets like China to bring returns to investors. 

By applying a discounted cash flow analysis, a fair market value of $153 is calculated, suggesting that DUOL share price is overvalued at this time.

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