The Rise And Fall Of Duolingo

Key Concepts

• Stock Rerating: A significant downward adjustment in a stock's valuation multiple due to changing investor sentiment or perceived future growth prospects.
• Growth Deceleration: A slowdown in the rate at which a company's revenue or earnings are increasing.
• Position Sizing: The practice of determining the appropriate amount of capital to allocate to a specific investment within a portfolio, based on risk tolerance and conviction.
• Volatility: The degree of variation of a trading price series over time, typically measured by the standard deviation of logarithmic returns.
• Durable Moat: A sustainable competitive advantage that protects a company's long-term profits and market share from competitors.
• Bookings: A forward-looking metric representing the value of contracts or subscriptions that a company has secured but not yet recognized as revenue.
• Monthly Active Users (MAU): The number of unique users who engage with a product or service within a given month.
• Daily Active Users (DAU): The number of unique users who engage with a product or service on a given day.
• Paid Subscribers: Users who have purchased a subscription to a service.
• Monetization: The process of converting something into money.
• Total Addressable Market (TAM): The total market demand for a product or service.
• AI Chip (TPU): Tensor Processing Unit, a custom-designed integrated circuit by Google for accelerating machine learning workloads.
• Unit Volume: The total number of units sold by a business.
• Inconsistent Portion Sizes: A lack of uniformity in the amount of food served in a meal.
• Standard Deviation: A measure of the amount of variation or dispersion of a set of values.

Duolingo Stock Analysis and Investor Strategy

Duolingo Stock Performance and Rerating Event

Duolingo's stock experienced a significant decline of 29% in a single day, attributed to investor concerns about future growth deceleration. This event is characterized as a "rerating" where investors adjust their valuation multiples downwards for stocks with high growth expectations that show signs of slowing. The speaker draws a parallel to Netflix's past experience, where a similar growth concern led to a 75% stock price drop. The core question for investors is how to react: sell, hold, or buy more. The speaker emphasizes that decisions made during such dramatic sell-offs can significantly impact future returns.

Duolingo's Business Fundamentals and Management Commentary

Despite the stock price drop, the speaker expresses admiration for Duolingo's management and their vision, particularly highlighting the CEO's commentary during the recent earnings call. The analysis delves into Duolingo's business fundamentals, including its portfolio, position sizing, and the damage being done by the stock's performance.

Personal Portfolio Context: Position Sizing and Risk Management

The speaker details their personal investment in Duolingo within the "Story Fund," an aggressive portfolio focused on volatile, fast-growing, subscription-based, or data-centric companies with high lifetime value. Duolingo is described as a company with high user engagement, boasting 50 million daily active users and more on a monthly basis.

Crucially, Duolingo has always been a small position (initially 2%, now 1% after the sell-off) in the speaker's portfolio. This intentional sizing was due to:

• Inherent Risk and Volatility: Smaller companies with higher volatility can experience significant price swings, making them harder to hold.
• Less Established Business Model: Compared to giants like Google, Netflix, or Amazon, Duolingo's moat and business model are considered less proven and more at an earlier stage of its growth arc.

The speaker contrasts this with their Google position, which is 13% of the portfolio and represents a $100,000 contribution, highlighting their higher conviction in Google. The $20,000 contribution to Duolingo means the maximum potential loss is limited to that amount, minimizing the overall portfolio impact (a 1% hit to NAV). This approach is framed as prudent investing, a strategy the speaker has advocated for months.

Historical Perspective: The Netflix Rerating Event

The speaker recounts their experience with Netflix around 2020-2022, where it was their top position. Netflix faced a growth slowdown due to subscriber churn, leading to a Wall Street rerating and a 75% stock price decline. This experience taught the speaker the importance of caution with companies heavily reliant on continued high growth and those with less established, more volatile stories. The current situation with Duolingo, being a small position, is not considered a "tragic event" like the Netflix experience was.

Duolingo's Growth Outlook and Investor Concerns

The primary driver for Duolingo's stock decline is the projected slowdown in bookings growth.

• Booking Growth: The Q4 bookings forecast was 22% year-over-year (19% constant currency), falling short of Wall Street's expectation of around 24%.
• Bookings as a Preview: Bookings are seen as a leading indicator of future revenue. Slower booking growth suggests decelerating revenue in the following year, which is a concern for high-multiple stocks.

Positive Fundamentals and Management's Strategic Shift

Despite the booking concerns, several positive fundamental aspects were highlighted:

• Subscription Revenue Growth: Grew by 45% and constitutes about 90% of total revenue.
• Monthly Active Users (MAU): Rebounded to 135 million, up 20% year-over-year, dispelling concerns about a previous decline.
• Daily Active Users (DAU): Surpassed 50 million (50.5 million), a level comparable to many top social media companies.
• Paid Subscribers: Increased by 34% year-over-year to 11.5 million.

The management's strategic shift is a key factor. The CEO, Luis von Ahn, articulated a vision to transform Duolingo into the world's leading education platform, leveraging AI. This involves:

• Focus on Teaching Better: Investing more in improving the learning experience and content quality.
• User Growth and Engagement: Prioritizing acquiring and retaining users over immediate monetization.
• Long-Term Opportunity: Aiming to scale to billions of users by creating an app that teaches "much better than anything that humanity has seen before," comparable to a human tutor.

This shift means a temporary de-emphasis on aggressively converting free users to paid subscribers, which is a deliberate choice to maximize long-term potential, even if it means lower near-term bookings. The speaker likens this strategy to Uber and Netflix, which prioritized growth and scale over immediate profitability.

Addressing AI and Competitive Threats

The CEO directly addressed concerns about AI and translation tools:

• ChatGPT: While ChatGPT can teach a few words, it lacks the long-term curriculum and engagement mechanisms necessary for years of language learning. Duolingo's strength lies in keeping users engaged daily over extended periods.
• Simultaneous Language Translation: The existence of live translation technology has not diminished the desire to learn languages, as many learn for hobbies, cultural reasons, or career opportunities. The speaker agrees with this assessment, noting that learning a language is often a hobby, similar to learning chess, where computers are superior but human interest persists.

The Danger of Letting Stock Price Dictate Opinion

A central argument is the danger of investors allowing stock price movements to dictate their opinion on a company's fundamentals. The speaker argues that this leads to emotional decision-making and missed opportunities. Examples cited include:

• Netflix: Investors panicked during its 75% decline, overlooking the underlying business strategy.
• Amazon: In 2022, the stock fell due to heavy CAPEX investment, but fundamentals like customer growth and gross profits continued to improve.
• Jeff Bezos's Amazon Experience: During a 90% stock crash, key business metrics like customer numbers and gross profits consistently improved, demonstrating a disconnect between stock price and fundamental health.

The speaker advocates for focusing on the "weight" of the company – its fundamental strength and long-term potential – rather than short-term market "voting."

Duolingo's Future Potential

While not comparing Duolingo to Amazon, the speaker believes there's an opportunity for it to become a "heavy company" with a massive user base and a well-liked product in a relevant industry. The speaker will continue to monitor the fundamentals and may even dollar-cost average into the position.

Google's AI Chip Advancement

Google's New AI Chip: Ironwood TPU

Google is making significant advancements in artificial intelligence hardware with its seventh-generation Tensor Processing Unit (TPU), codenamed "Ironwood." This custom-designed chip is set to be publicly available in the coming weeks.

• Capabilities: Ironwood is designed to handle demanding AI tasks, including training large models and powering real-time AI agents and chatbots.
• Scalability: It can connect up to 9,216 chips in a single pod, eliminating data bottlenecks for the most demanding models and enabling the scaling of large, data-intensive applications.
• Performance: Google claims Ironwood is more than four times faster than its predecessor.
• Target Market: The chip is positioned to compete with Nvidia's offerings in the AI hardware space.
• Adoption: AI startup Anthropic plans to use up to 1 million of these new TPUs for its cloud model.

The speaker notes that Google's consistent investment in these projects over decades has led to this advanced chip development, highlighting Google's multifaceted strengths beyond its core services.

Chipotle's "Fail of the Week" and Proposed Solution

Chipotle's Struggles and Inconsistent Portions

Chipotle is experiencing a "fail of the week" due to its stock performance and operational issues.

• Stock Performance: The stock is down approximately 50% year-to-date.
• Declining Average Revenue per Location: Despite opening new locations, the revenue generated per store is decreasing.
• Inconsistent Portion Sizes: This is identified as a primary customer frustration and a significant problem. Anecdotal evidence and viral social media posts illustrate the disparity in portion sizes, particularly between in-person and online orders.
• Customer Frustration: Customers feel "ripped off" due to the inconsistency, making the experience feel like a gamble.

The "Nod" Anecdote and Customer Responsibility

The previous CEO of Chipotle suggested customers could subtly signal to employees for larger portions. However, the speaker argues that customers should not be responsible for ensuring they receive the correct portion size for what they pay.

Data and Legal Evidence of Inconsistency

• Viral Social Media: A tweet detailing a significant difference in burrito size between in-person and online orders gained millions of views, indicating widespread customer experience.
• Wells Fargo Analyst Study: An analyst ordered 100 burritos with identical orders, revealing wide variations in bowl weight, with some being three standard deviations below the median, confirming the issue is not merely anecdotal but statistically significant.
• Lawsuits: Chipotle has faced lawsuits related to inconsistent portion sizes.

Management's Response and the Proposed Solution

Chipotle management has attributed performance issues to macroeconomic pressures and has attempted employee training, but a definitive solution has been lacking. The speaker proposes a simple and effective fix: implementing food scales.

The Solution: Food Scales

• Methodology: Restaurants like "Moettas" use food scales to ensure consistent portioning. Before adding protein, the plate is placed on a scale, zeroed out, and then the correct weight of food is added.
• Benefits:
  • Consistency: Guarantees customers receive the exact amount of food they pay for, every time.
  • Customer Satisfaction: Eliminates a major source of frustration and improves the customer experience.
  • Cost-Effective: Food scales are inexpensive and easy to implement.
  • Minimal Impact on Throughput: Adds only 2-3 seconds per order, with minimal impact on line speed.

By adopting food scales, Chipotle can address a critical operational flaw, improve product consistency, and potentially drive unit volume growth as customers know what to expect.