When I first wrote about Duolingo (DUOL, Financial), the stock was facing skepticism, weighed down by fears that generative AI could make Duolingo irrelevant. The critics argued that tools like ChatGPT might eliminate the need to learn languages altogether, making apps like Duolingo unnecessary. Fast forward, and Duolingo has not only survived but thrived, with its stock surging over 100%, far surpassing my initial price target of $257. To be honest, I didn't anticipate such an aggressive surge, but my thesis on the company remains intact.

Learning a language isn't just about understanding words or grammar. It's about forming connections, exploring cultures, and engaging with the world in new ways. That's why I believe AI tools, far from being a threat, are actually enhancing Duolingo's platform. The company is using AI to create content faster, personalize the experience, and engage learners in ways that weren't possible before. Duolingo is evolving, not just surviving.

In this article, I'll break down Duolingo's financial performance, highlight my key drivers behind its growth, and share why I think this company is uniquely positioned to dominate the education-tech space for years to come.

Financials

Duolingo's growth story keeps getting better. In Q3 2024, the company reported $193 million in revenue, up 40% year over year (YoY), and $212 million in bookings, which grew 38% YoY. Over the past three years, bookings have grown at an impressive 42% compound annual growth rate (CAGR). These numbers show how well Duolingo has scaled its platform, especially as it converts free users into paid subscribers.

Speaking of paid subscribers, they've now reached 8.6 million, up 47% YoY. This growth reflects Duolingo's ability to turn its freemium model into a powerful funnel for paid features.

Six quarters ago, Duolingo turned GAAP profitable, and this quarter it reported $23.4 million in net income, with a 12% margin. That profitability didn't come out of nowhere, it's the result of a highly scalable business model. Revenue grew 40% YoY, but operating expenses rose by only 20%, which is a sign of operating leverage at work. Duolingo's robust balance sheet has been a significant contributor to its profitability. With $881 million in cash and no debt, $11 million of net income this quarter was derived from interest earned on that cash, a nice side benefit of today's high-interest rates.

Gross margins dipped slightly this quarter. This was expected, given the rollout of Duolingo Max and its Video Call feature, which comes with incremental costs for large language model (LLM) queries. Duolingo Max brings in more gross profit dollars per subscriber, even if the margins as a percentage are slightly lower. It's a trade-off that makes sense, especially since Max is also driving stronger free cash flow (FCF).

FCF grew 61% YoY to $51 million in Q3, with a 27% FCF margin. Combine that with revenue growth, and Duolingo achieves a "Rule of 40" score of 67%.

User engagement remains strong, with daily active users (DAU) up 54% YoY. That's impressive, considering last year's 60%-plus growth. Monthly active users (MAU) also grew by 36% YoY, and DAU now represents about one-third of MAU.

Source: FinChat

Stock compensation grew 14% YoY but it only represents 15% of revenue, down from 18.5% last year. Management expects that total shareholder dilution will be limited to 1% this year.

Outlook

Looking ahead, Duolingo expects bookings to grow by 36% and revenue by 40% in Q4. Gross margins are likely to dip slightly, about 100 basis points due to higher costs from scaling Max and its generative AI features. But that's not a red flag to me. The company is investing in growth, and it's paying off.

Profitability is also moving in the right direction. Duolingo has raised its full-year adjusted EBITDA margin guidance to 25.5%, up 8 percentage points from last year. For Q4, adjusted EBITDA margins are expected to reach 24.4%, showing continued leverage in areas like research and development, as well as marketing.

Q3 marked a turning point for Duolingo Max, as it began to make a meaningful impact on the company's financial performance. The Q4 guidance incorporates the growing contribution of Max and its Video Call feature, signaling the importance of these offerings as key growth drivers.

As Duolingo continues to refine its generative AI-powered features and scale Max to more users, the company remains focused on sustaining strong revenue growth while steadily improving profitability. With strategic investments in R&D and disciplined cost management, Duolingo is well-positioned to carry its momentum into 2024 and beyond.

Breaking down 5 growth drivers

Duolingo's success is being fueled by some key strategies and insights that, in my opinion, set the company apart. Let's break down what's driving its growth and where I think the real opportunities lie.

1. TAM

The number of people learning a language globally is about 2 billion, and Duolingo's MAU is just over 113 million. That's a massive runway for growth. What's exciting to me is that this TAM accounts only for language. Over the longer term, it is expected other subjects to start helping, too, such as math and music.

If they can crack the code on math and music as they did with language learning, Duolingo could open up entirely new growth engines. It's ambitious, but that's what makes this company so interesting to follow.

Duolingo is already the top language learning app by downloads, and its brand recognition and data lead give it a head start in any adjacent markets it chooses to enter.

Source: Statista

2. Monetization

One of Duolingo's most attractive features is its freemium model. The free tier is so good that the vast majority of its users stick with it, creating a massive barrier to entry for competitors. CEO Luis von Ahn has always been clear about the company's mission to make education accessible, saying, “We've worked hard to keep Duolingo free because we want education to be accessible to everyone”. Duolingo earns revenue from ads on its free tier, but the real value lies in the massive data it collects. This data helps improve its LLM capabilities, enhance teaching methods, and make the platform more engaging. With this, Duolingo has more data than anybody in history about how people learn languages.

But once users are in the ecosystem, Duolingo faces two big challenges: monetizing better and keeping users engaged. Duolingo knows it needs to monetize better without losing its massive user base to increase its average revenue per user (ARPU). The hardest thing about learning something by ourselves is keeping users engaged and motivated. It's experimenting with new ways to make the app engaging and addictive. That's why Duolingo invests heavily in R&D to gamify the experience and keep users hooked. The app doesn't just teach, it entertains, and motivates in ways that set it apart.

Another opportunity is resurrected users who return after a long hiatus. These users now make up more than half of Duolingo's top-funnel users. If the company can figure out how to monetize this group effectively, it could see a major lift in its metrics. And with generative AI, the company is increasing the number of experiments that run per quarter to optimize features and offers, which could unlock new ways to monetize these users. For context, the success rate for the test is about 50%, meaning every test that the company runs has about a 50% chance of succeeding.

3. Max vs Super

Duolingo Max is still in its early days, but it's already becoming a key growth driver. The new, GenAI-powered Duolingo Max subscription tier represents a big step forward in Duolingo's mission to teach as effectively as a human tutor.

While Duolingo Super subscription focuses on convenience (like ad-free learning and unlimited lives), Max is about immersion and improving conversational skills, optimized by its AI-powered "Video Call with Lily”. Lily is a virtual tutor who can simulate real conversations and even reference past discussions to make the experience feel more personal.

There's still plenty of room to refine it, though. Right now, Lily exists in a sort of bubble where real-world events don't matter. For example, Lily can't discuss today's news or react to current events, but that's expected to change soon. Imagine calling Lily and having her talk about something happening in real time. That's where the potential to enhance engagement really lies.

Currently, Max is available to about 50% of DAU, with plans to expand that to 60–70% by the end of the year. As Max becomes accessible in more countries and courses, it's likely to have a big impact on Duolingo's revenue. Rolling out Max to additional countries and courses should give the company a significant boost in ARPU. And while Max costs twice as much as Super, the added value it offers makes it an easy sell for serious learners.

4. iPhone vs Android Users

One of the more interesting insights from the recent updates is the difference in monetization between iPhone and Android users. As the CEO explained, “Android users just don't monetize, as well as iPhone users. That's industrywide. This is not just Duolingo. It usually is the case that they probably have lower purchasing power”. Unsurprisingly, the company prioritizes iPhone for new feature rollouts, with Android trailing by three to six months.

But English learners tend to be more focused using features like the "Video Call with Lily" twice as much as other language learners. This creates a unique opportunity for Max to gain traction on Android, where users are particularly focused on learning English. I see this as a chance for Duolingo to close the monetization gap and unlock incremental revenue.

5. Costs Optimization

This is where Duolingo's operating leverage and efficiencies really help it scale profitably, in my opinion.

Duolingo has grown largely through word of mouth, and the company's humorous campaigns on TikTok and Instagram have built a massive following (13.4 million on TikTok alone), creating brand awareness practically for free. Localized marketing is also helping the company grow. Duolingo is adding new managers in countries like Turkey and Italy to tailor its campaigns, proving that humor (and the green owl) translates across cultures.

AI investments are another area where Duolingo is seeing big wins. Generative AI has drastically reduced the time it takes to create new LLM content, making it faster and cheaper to deliver fresh, engaging material. And the costs are only going to keep coming down. Management has made it clear that for now, the priority is building the best features possible rather than optimizing costs, knowing that LLM expenses will naturally decrease over time.

This leverage will unlock new opportunities. With lower costs, Duolingo can start offering premium features like Max at prices that make sense for developing markets. These regions, where English learners are eager to practice conversational skills, could be the next major growth area for the company. And if Duolingo gets the pricing right, this could unlock huge new markets.

Valuation

Duolingo is using GenAI to scale the business faster with more quality. Duolingo's stock has had an incredible run since the market realized that GenAI would enhance its business rather than disrupt it. While a pullback is tempting to anticipate, I think the current price is fair.

The company trades at a forward price-to-sales multiple of 17x and a forward price-to-earnings (P/E) ratio of 68x. I agree that those numbers are high, but for a company growing bookings at a CAGR of 42% over three years, coupled with expanding adjusted EBITDA margins, supports a premium valuation.

Using a discounted cash flow (DCF) model that combines multiple-based approaches and a perpetuity growth model, I estimate Duolingo's intrinsic value at $328 per share, which is slightly below its current price. My assumptions were conservative, so there could be upside if the company continues to outperform. That said, I think the stock is fairly priced at these levels, and I'd wait for a pullback before adding more.

Source: Author

My final take

Duolingo is not just surviving the AI revolution but leading it, redefining what online education can look like. The company has turned generative AI into a growth accelerant, creating a product that's engaging, scalable, and uniquely positioned in the market. From its freemium model to its innovative subscription tiers, Duolingo is playing the long game, and it's playing it well.

For me, Duolingo remains a long-term winner. I'd love to add more shares on any weakness because I believe this company is just getting started. With its massive TAM, strong brand, and innovative roadmap, Duolingo is a name I'm happy to hold for years to come.