In my previous article about Duolingo (NASDAQ:DUOL), I argued that the stock was fairly valued with a price target of $328. That target was roughly 5% above its trading price at publication. I explained that despite widespread concerns that generative AI might disrupt traditional language learning, Duolingo's innovative freemium model and early adoption of AI would drive sustainable, long-term growth. At that time, I also maintained that the valuation was a bit stretched, so any weakness in the stock would represent an attractive buying opportunity.
Fast forward to its Q4 2024 earnings, Duolingo delivered record user metrics, robust revenue, and strong bookings growth. Revenue increased 39% YoY to $209.6 million, and total bookings rose by 42% to $271.6 million. Yet, despite these solid fundamentals, the stock dropped over 16% post-earnings. This isn't the first time such volatility has occurred. After Q1 2024, the stock fell by more than 20%. Despite this short-term bump, the long-term growth story remains intact.
Duolingo: The Owl is Alive
Source: Gurufocus
I believe the recent stock drop was driven by two main factors. First, Duolingo missed Wall Street's bottom-line expectations. Analysts were anticipating $0.48 earnings per share (EPS), but the company reported only $0.28, and when a company with its valuation misses estimates, the market reacts sharply. Second, management warned that margins would contract temporarily. In 2025, gross margins are expected to contract by 170 basis points due to the impact of Duolingo Max, with an even tougher 300 bps contraction anticipated in the first half of the year as AI costs remain unoptimized. I view this as short-term pain for long-term gain, although it does introduce some uncertainty until management demonstrates clear improvements in revenue and profitability from these investments.
Fundamentals
Duolingo's Q4 2024 fundamentals continue to impress. The company reported revenue of $209.6 million, a 39% increase year over year, and total bookings of $271.6 million, growing 42% compared to the same quarter last year. These numbers reflect the strength of a business that is successfully converting a massive freemium base into paying subscribers. Paid subscribers have climbed to 9.5 million, up 44% year over year, pushing subscriber penetration to 8.8%. Daily active users (DAUs) have grown by 51% to reach over 40 million, while monthly active users (MAUs) have increased by 32% to 116.7 million. The improved DAU/MAU ratio signals that users are not just signing up but engaging consistently, a critical element in driving higher conversion rates and overall monetization.
The company continues to leverage its massive social media following to run creative, viral campaigns that significantly boost brand visibility. While word of mouth remains one of its most powerful growth engines, Duolingo consistently delivers standout campaigns, such as the recent fake death stunt of its mascot. In that campaign, the mascot faked his own death, only to make a dramatic comeback when dedicated learners completed 50 billion XP just in time to revive our favorite owl. This clever tactic not only reinforces the fun, engaging identity of the brand but also keeps the community actively involved.
Management's strategy of aggressively pushing new product features is paying off, with paid subscribers increasing faster than MAUs. The company has reduced the display of external ads, sacrificing some advertising revenue. This decision is strategic, enabling Duolingo to increase internal promotion of its higher-tier subscriptions, particularly the innovative AI-powered Video Call with Lily.
Lily, Duolingo's virtual tutor, simulates real conversations by referencing previous interactions. Management is actively working to enhance her capabilities by planning to give her memory and a more interactive persona so that she can recall previous conversations, ask personal questions, and even share aspects of her own story. This will create a more immersive and personalized learning experience.
Although Video Call with Lily is available only in the highest tier (Duolingo Max) due to the high inference costs, Duolingo remains committed to its core mission of making education more affordable. Management has plans to extend these capabilities to lower tiers once AI costs come down. For now, Max represents only about 5% of the total subscriber base, but its contribution to both bookings and user engagement is growing rapidly.
This is also applicable to international expansion. In some of its poorest international markets, current pricing for premium offerings is considered too high. Management acknowledges this challenge but has been careful to set prices such that the company does not incur losses. As the cost of large language model (LLM) queries falls, Duolingo expects to pass on those savings, eventually making premium features accessible to a broader range of consumers, creating another tailwind for the company.
On the margin front, gross margins contracted by 125 bps this quarter due to the incremental costs associated with Duolingo Max. Although these costs lower the margin percentage, Max generates higher gross profit dollars per subscriber. Importantly, operating expenses grew more slowly than revenue (by 20% compared to a 39% revenue increase) underscoring Duolingo's operating leverage.
The company has now been GAAP profitable for seven consecutive quarters, and its free cash flow reached $80.9 million in Q4, achieving a Rule of 40 score of 77. Combined with a robust balance sheet holding $881 million in cash and no debt, these fundamentals provide Duolingo with the flexibility to reinvest in growth initiatives.
Shifting to how AI is improving Duolingo, the company ran more product experiments in 2024 than ever before and is set to accelerate this velocity in 2025. Leveraging generative AI, Duolingo can rapidly iterate on features, optimize its product offerings, and tailor the learning experience to its users' needs.
Beyond language learning, the company is increasing its portfolio with new verticals such as math and music. Although these new subjects currently serve around 3 million daily active users combined, they are still in their early stages. In math, for example, Duolingo's current offerings extend only through the 5th grade, as creating content for math is very challenging as every topic needs a different exercise. However, with AI-enhanced content creation that now includes reasoning capabilities, the company expects to rapidly expand its math curriculum to cover all grades through college. This diversification is an important part of Duolingo's strategy to tap into a much larger total addressable market of 2 billion.
Looking at guidance, management expects 2025 revenue to grow by roughly 30% YoY, reaching around $971 million. Furthermore, adjusted EBITDA margins are projected to improve by nearly 200 basis points, reaching approximately 27.5%. Despite the gross margin pressure, adjusted EBITDA is expected to expand, showing operational leverage.
Valuation
From a valuation perspective, Duolingo continues to trade at a premium. The stock is currently priced at a P/S multiple of 19x, with a forward P/S of about 14x and a price-to-FCF ratio of 54x. Although these metrics may seem elevated on an absolute basis, they are supported by the company's robust growth, in my opinion. Its bookings have grown at a 42% CAGR over the past three years and its rapid expansion in MAUs and DAUs, as well as the high conversion rate from free to paid subscribers.
When I update my model, I take the revenue guidance for 2025 and assume that growth will gradually taper. I factor in near-term margin pressures (primarily due to high AI costs linked to Duolingo Max) while also anticipating that continued innovation, including enhancements to Lily and expansion into new verticals, will help restore and even improve margins over time. Despite these temporary headwinds, I believe the company's long-term growth prospects justify the premium valuation, and I've slightly raised my price target to $343 per share, which offers roughly a 12% upside and keeps the stock within fair value.
Duolingo: The Owl is Alive
Source: Author
Conclusion
Despite short-term headwinds that may temporarily affect profitability and investor sentiment, my long-term thesis on Duolingo remains on track. The company continues to expand its user base and improve monetization through innovative product features and engaging marketing strategies.
Strategic investments in generative AI are designed to drive future efficiency and enhance the learning experience, even if they currently weigh on margins. Furthermore, Duolingo's push into new verticals, such as math and music, expands its total addressable market and diversifies its revenue streams.
I remain confident that these efforts will allow the company to outpace competitors and deliver exceptional value over time. In my view, the recent stock dip represents a temporary setback rather than a fundamental weakness. For me, Duolingo continues to be a long-term winner, and I will remain a shareholder while looking to add more shares on any future weakness.
