Down 29%, Is Duolingo a Buy on the Dip?

After tumbling from a peak it set in May, shares of Duolingo (NASDAQ: DUOL) recently received a positive bump from a Wall Street investment bank that follows its business closely.

Duolingo stock popped about 4% higher when the market opened on Friday, July 26. Investors were responding to encouraging words from Bank of America analyst Curtis Nagle. Citing a 31% price drop following the company's first-quarter earnings report in May, Nagle upgraded the stock from a neutral to a buy rating.

Nagle also maintained Bank of America's $245-per-share price target on Duolingo stock. This target is significantly lower than several other investment banks but it still implies a gain of about 40% from recent prices.

Wall Street analysts are bullish for this stock but that doesn't necessarily mean it's a smart buy now for your portfolio. Before making any decisions, you should at least weigh reasons to buy Duolingo against some of its challenges.

Why Duolingo is a good stock to buy

The company behind the internet's favorite education application is gaining market share at a mind-blowing pace. Duolingo doesn't report second-quarter results until Wednesday, Aug. 7, but growth during the first three months of 2024 was off the charts.

Duolingo's free-to-use smartphone application is gaining popularity at an eye-popping pace. The number of daily active users soared to 31.4 million in the first quarter, which was 54% more than the previous-year period.

Duolingo's popular application converts free users to paid subscribers at an encouraging rate. The company reported 7.4 million paid subscribers at the end of March, which was 54% more than it had a year earlier.

Financial statements for education businesses usually show sales and marketing expenses that rise at least as fast as total revenue. Duolingo takes a unique marketing approach and it's working.

DUOL Revenue (TTM) data by YCharts

The company relies on hilarious social media posts that get shared extensively and cost the company very little to produce. The April 1 promotion of a Duolingo ice show that doesn't exist racked up over 20 million views on different social media outlets and it's a long way from the company's most successful low-cost marketing ploy.

With marketing expenses in check Duolingo's bottom line recently entered positive territory. The company earned $15.8 million in the first quarter compared to an $8.5 million loss in the previous-year period.

Nobody knows how many potential premium subscribers there are around the globe but it's probably a lot more than the 7.4 million reported in the first quarter. Now that Duolingo has proven its ability to produce profits, earnings could soar in the years ahead.

Reason to remain cautious

Duolingo's growth rate is amazing but it can't continue growing at its present pace forever. A deceleration could begin five years from now or it could start in the second half of 2024.

Duolingo stock has been trading for around 44 times forward-looking earnings expectations. If the business decelerates too quickly or the stock market begins worrying about a general recession, the stock could get beaten down a lot further than it already has.

A buy now?

Duolingo is constantly investing to provide learners with fun and engaging learning experiences that convert free users to paid subscribers. In theory, its lead on any potential competitors will continue to grow as its lessons improve.

Duolingo's valuation implies a lot of growth in the years ahead but long-term investors can come out way ahead over the long run even if this business grows at one-third of its present pace. Without any serious contenders on the horizon, attracting enough new subscribers to produce satisfying gains seems like a reasonable assumption. Buying this stock on the dip looks like the right move for most growth-seeking investors.

Bank of America is an advertising partner of The Ascent, a Motley Fool company. Cory Renauer has positions in Duolingo. The Motley Fool has positions in and recommends Bank of America and Duolingo. The Motley Fool has a disclosure policy .