We recently compiled a list of the 12 Best Aggressive Growth Stocks To Buy According to Hedge Funds. In this article, we are going to take a look at where Duolingo, Inc. (NASDAQ:DUOL) stands against the other aggressive growth stocks.
For a large portion of investors who put money in the market, growth is the primary objective. The stocks that these investors prefer are also stocks that are either currently exhibiting strong revenue growth or have product strengths or other competitive advantages that can ensure that they will dominate their markets and grow in the future.
Broadly speaking, it is possible to identify such stocks by looking at which industries are expected to grow strongly. A few years ago, semiconductor design and fabrication was one such sector. Back then, the world’s largest integrated chip manufacturer known for its Core processor lineup had started to struggle. The nature of the semiconductor industry which requires years of research expertise and billions of dollars in capital expenditure meant that the market was not only open to new players but also that this opening favored incumbents that already had the necessary investments and expertise in place.
This gap led to the price-to-earnings (P/E) ratio of the firm which ranked 3rd on our list of 10 AI Stocks That Will Skyrocket to touch astronomically high levels as soon as the firm started to turn a profit. As an illustration, consider the P/E ratio of this stock at Q1 2018’s close. The ratio back then was 111, while the integrated chip manufacturer was trading at 19 and the Taiwanese contract chip manufacturer which ranks 2nd on our list of 10 Best Tech Stocks For Long-Term Investment traded at 16.11. During the same period, Wall Street’s favorite AI GPU stock whose shares have gained 700%+ since OpenAI publicly released ChatGPT was trading at a P/E ratio of 37.
Naturally, this indicated that investors were betting heavily on the firm to grow. Since 2018’s first quarter, its shares have gained a whopping 1,204% while the GPU company has gained 2,175% and the integrated chip manufacturer is down by 57.6%. Between its fiscal years 2017 to the latest trailing-twelve-month revenue, the growth stock that traded at a P/E ratio of 111 in 2018 has grown revenue by 358%, so it’s safe to say that in this case, growth investors were right, and their investments if dearly held since then have outpaced the firm’s revenue in growth terms.
Therein lies the magic of growth stocks, which can generate substantial returns for investors. However, as is the case with all things in life, this promise also comes with a dark side. Research from the University of Michigan shows that growth stocks are punished harder than value stocks in case of negative earnings surprises. For their research, the researchers analyzed consensus earnings forecasts, quarterly share prices, stock prices, P/E ratios, and other variables for 13 years to determine the returns of growth and value stocks that missed or beat analyst earnings estimates.
By bifurcating their results across five categories starting from Low Growth and ending at High Growth, they demonstrate a clear difference between the post-earnings stock returns of growth and non-growth stocks. For the Low Growth stocks, a negative earnings surprise led to -3.57% in share price returns starting two days following the report and ending before the next report. The High Growth stocks led the Low Growth stocks by 3.75 percentage points in negative returns as they lost 7.32% over the same period after posting a negative earnings surprise. The 3.75 percentage point differential is key when we analyze these two categories’ stock price performance after positive earnings surprises. This is because while the Low Growth stocks gained 5.44% after the earnings surprise, the High Growth stocks led them by only 0.88 percentage points by gaining 6.32%.
Similarly, not only are growth stocks punished harder if they miss investor expectations, but the share price drops can make earlier optimism regarding their fortunes appear misplaced as well. The best example of this fact is the software-as-a-service (SaaS) industry. SaaS firms were the pinnacle of growth investing because of their business model which allows them to earn recurring revenue through sizable contracts while keeping costs low. Investor optimism surrounding SaaS stock touched a feverish pitch in Q1 2021 when their median EV/Revenue multiple sat at 14.1x. This meant that the firms’ market capitalization and debt minus cash and other assets were valued 14 times their sales. But, by Q4 2022 this had dropped to 4.6x as a combination of factors such as higher rates leading to tighter business spending and the pivot towards artificial intelligence soured sentiment. SaaS firms were particularly hurt since AI enables businesses to self-develop software which reduces the need for SaaS products and services.
So, with the landscape surrounding growth stocks being as dynamic as their share prices, we decided to look at some aggressive growth stocks with high revenue growth and significant hedge fund interest.
Our Methodology
To compile our list of the best aggressive growth stocks, we first sifted out 12 stocks with annual latest quarter revenue growth greater than 35% from multiple growth ETFs. The stocks were then ranked by the number of hedge funds that had bought the shares during Q3 2024.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
A close up macro image of someone using a mobile device to learn a new language.
Duolingo, Inc. (NASDAQ:DUOL)
Revenue Growth: 39.9%
Number of Hedge Fund Investors In Q3 2024: 31
Duolingo, Inc. (NASDAQ:DUOL) is one of the few software-based language learning-focused firms in the world. As it is one of the earliest movers in the industry, the firm has managed to create a sizable moat for itself fueled particularly through its profitability during the coronavirus pandemic. Duolingo, Inc. (NASDAQ:DUOL) has also managed to capitalize on the surge in generative artificial intelligence technologies by introducing new features such as Video Calls and Duocons to try to use AI to replace traditional language teachers. Its focus on technology sets the firm up well to capitalize on young users who are more tech-savvy. At the same time, like any other social media or associated firm, Duolingo, Inc. (NASDAQ:DUOL)’s hypothesis depends on its monthly active users, their growth, and retention. The firm boasts of having 100 million monthly active users and 8 million subscribers, which hints at the potential that lies ahead of it in terms of market penetration.
Baron Funds mentioned Duolingo, Inc. (NASDAQ:DUOL) in its Q3 2024 investor letter. Here is what the fund said:
“Duolingo, Inc. (NASDAQ:DUOL) is the world’s leading language learning app with over 100 million monthly active users, known for its effective gamification and high engagement. After monitoring the company over the past year and a half, we developed conviction to buy the stock for a few reasons. The company has maintained premium levels of user growth (daily average user growth of over 50%) and revenue growth (40%-plus), executed well against their product roadmap, gained early traction with new functionality, and maintained impressive 40%-plus incremental margins. We view the founder-led management team as best in class, technically capable (CEO and CTO both earned PhDs in machine learning from Carnegie Mellon University), and product focused. We initiated a position in the quarter as the share price fell to what we deemed attractive levels from a long-term valuation perspective, coupled with material catalysts on the horizon, particularly the broader launch of AI functionality (branded “Max”) that enables users to have real-time conversations with AI based characters and a substantial improvement of the company’s Advanced English offering. We believe that these two initiatives take Duolingo from more of a hobby app to a company that can address the broader market of 1.8 billion people learning English today. As these products roll-out in the coming quarters, we believe their adoption should drive the realization of higher pricing, faster revenue growth, lower churn, and continued margin improvement. We also believe there is additional optionality in newer products such as math and music, which are earlier in their product evolution.”
Overall DUOL ranks 9th on our list of the aggressive growth stocks to buy according to hedge funds. While we acknowledge the potential of DUOL as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than DUOL but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article is originally published at Insider Monkey.
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