DUOL is held; current price lacks sufficient safety margin given high risk from new customer-acquisition strategy.

So, in light of the threat posed by artificial intelligence, the Duolingo management team chose its response. What is this response? Well, they focus on attracting customers even at the expense of profitability.

This means more free features to attract customers to the platform, even if it means less revenue generation from those same customers. So, what this means for investors is likely increased customer engagement and a rise in daily active users, which management is targeting at 100 million users over the next two years.

But this will come at a cost. What this cost will be remains a big question mark. However, the market has appreciated this response for now, as Duolingo's share price has recovered strongly from its lows earlier this year.

So, does this make Duolingo stock a buying opportunity right now? Let's answer this question together by looking at the company's long-term performance, comparing it to its valuation, and determining whether it represents an attractive risk- reward situation for long-term investors .

Before the threat of artificial intelligence and the increasing efficiency and competition not only from artificial intelligence, but also from other language translation offerings from different technology companies, the need to learn a completely new language decreased.

Duolingo has been doing well in expanding its business, with its revenue growing from around 100 million in 2020 to more than 1.15 billion over the past twelve months.

The Duolingo app is very popular among language learners, and it still is.

What's even more impressive is that Duolingo was leveraging this revenue growth to boost profitability. This is something the management team highlighted at a recent investor conference, where they said: "Perhaps we have overemphasized internal revenue and profitability."

"This cost us an expansion of our market share, where we could have gained additional customers who would have added much greater value to the company's shareholders in the long run, rather than focusing on short-term profitability."

They have worked to improve profitability significantly since 2022, when their operating margins were -30% and then rose to 14.2%. This is common among many technology companies, such as Salesforce, UI Path, Upwork, and others including Duolingo, which follow a similar pattern in profitability.

Those efforts are now paying off, as there has been no actual recession, but those companies have not accelerated the pace of spending. They remained cautious, and this led to improved profitability for all the companies mentioned above.

Duolingo's profits reached record levels of 14%. However, this new strategy, which focuses on acquiring customers at the expense of profitability and revenue generation, is likely to keep Duolingo's margins at least the same, or perhaps even start to decline again.

We have already seen some of this decline in returns on invested capital, which were approaching 40% and have dropped to 30%. These are significant improvements compared to 2021, when the rate was -30%.

Therefore, the decline is likely to continue, but even at this level, it represents more than double the company's weighted average cost of capital. So, it's still a good number, even if the number is trending downwards.

But this downward trend is likely to be short-term only if they actually attract as many customers as they believe with this new policy. In the long term, the return on invested capital may trend upwards and return to pre-peak levels , and even surpass its previous peak.

So, I'm really interested in taking another look at the valuation, because, as I mentioned in the introduction, the stock price has recovered significantly since its lows in April when it fell to around $89.

It has now recovered to $143, but the valuation is still not high.

It is trading at a forward price-to-earnings ratio of 19. This is still close to the lowest trading level for this stock over the past few years. Therefore, despite the improved share price, the increase in earnings per share and earnings per share forecasts make Duolingo's stock appear slightly undervalued , even considering the high risks.

I also updated Duolingo's discounted cash flow valuation today. The main consideration was a lower estimated risk to the company, which caused the fair value to rise to $149. The current market price is $143.

Therefore, it appears to be valued at its fair worth . You could say it's slightly undervalued, but I wouldn't do that because I like to apply a safety margin of 5 to 10% on average, and for a more serious than usual situation like Duolingo, I prefer to apply a larger safety margin.

Therefore, I would say that this stock appears to be fair valued at slightly less than its true value at the moment . Therefore , given the high risk the company faces relative to its fair value, I will wait for a better price to enter and buy Duolingo stock.

Therefore, today I will confirm my " hold" recommendation for this business.