Calculating Risk Foolishly, Vol. 4: ETSY v. DUOL

27:19And we just heard, unsurprisingly, that Etsy is not doing great with this one. So plus one for Etsy. Yasser, yes or no, did Duolingo report a return on equity of 15 % or more in the previous year? So the last reported return on equity is almost 40 % for Duolingo. However, it was not that way for the previous part of the year, where it was actually below 15%. And the reason why the return on equity was so high at Q3 was because of that one-time tax benefit that I had mentioned earlier. But generally speaking, the direction of ROE for Duolingo has been up and to the right over the past three years.

28:02And Yasser, there are many ways of looking into financial statements. We're now closing up the financial section here, and we ignored a lot of other things I care about and look at. For example, how much cash the company has on its balance sheet, how much debt. How about return on equity in the mark of 15 %? What can that teach us as investors? Well, usually it's a very quick signal to most investors about how well management is doing in terms of generating returns for the business. So positive, profitable returns for the business. And there are many ways that that can be gamed, you know, either by stock buybacks or some acquisitions or debt taking debt for some reason.

28:40But generally speaking, it's a fair kind of indicator of how efficient and how well management is allocating capital and generating returns on those allocations. Thank you for that. And as we close up the financial section, let me just mention, I don't think I actually use the phrase return on equity at any point in my Rule Breaker investing book of last year. This is not necessarily something that Rule Breakers in particular pay that much attention to. Many of our rule breaker companies can't put up a great mark because they're at an earlier stage. But in general, a company that can create return on equity of 15 percent or more is basically consistently compounding shareholder capital at a good attractive rate without relying on excessive leverage and other ways, as Yasser mentioned, to manipulate their financials.

29:29So it's not the only number that counts here, but looked at in relation to the other 24 questions, it's all part of our mix. So with that said, we've now covered 10 of our 25 questions. We've had some quantifiable ones. We've had some qualitative ones. We're going to continue with a nice mix as we proceed forward to section number three. Now, section number three is all about the competition. Our next three questions are focused on competition. something very important for every company, I would say, especially Rule Breaker-like stocks, including Etsy and Duolingo. And in fact, I should update the score before we jump forward.

30:08One section, I have Etsy presently counting up to three and Duolingo counting up to one and a half. Again, the higher the number, the higher the risk of the stock we're researching. Let's now move to the competition section. And question number 11, Alicia, I entitled this one underdog. So is the company here, is Etsy free of any direct competitors that have substantially greater financial resources? Is the company free of any big dogs turning it into an underdog? No, Etsy is not free of direct competitors that have more financial resources. So Etsy has 1.5 billion in cash and short-term investments, and it has more debt than that at almost$3 billion in long-term debt.

30:59Amazon, while it does have some debt, has more resources than Etsy, and so does Shopify. Again, they have debt, but they have more cash and more than Etsy. So not surprising at all that a company like Etsy, which I do view as an underdog, and that is the name of question number 11, that it might have some big competitors in its e-commerce space. Yasser, what about Duolingo? Is Duolingo free of any direct competitors that have substantially greater financial resources? So I would say Duolingo is more of a top dog than an underdog. It is a market leader. It has competitors like Babbel, like Rosetta Stone, which are well-established, but Duolingo does surpass them in terms of user-based revenue share and brand awareness.

31:42So I would say it's a top dog. I agree. And that's a real contrast. You know, at least as I recall, I think Etsy got started before Duolingo. So if that's true, Etsy has been around longer, has had more opportunity to grow, compound, and be nasty as a competitor. And yet it is much more vulnerable. Duolingo is in a position, admittedly in a smaller industry, but is in a position where it is not the underdog. So plus one then for Etsy, bringing it up to four. Let's move on to question number 12. Kind of looks at the other side of the coin. So question number 12, I've entitled Goliath. And let me turn to Alicia and Etsy.

32:21Alicia, is Etsy free of any disruptive upstarts visibly challenging its business model? Well, so there are no true disruptors in this space that are completely changing the model, but there are smaller alternatives to Etsy. So there's Folksey for handmade goods in the UK, and that looks a lot like Etsy to me. There's also Society6 if you want art prints. Even Michaels opened up a marketplace for creatives to sell. So no disruptor per se, but definitely a lot of competition. Would you want to give it a half point here or do you say yes, it is free of disruptive upstarts visibly challenging its business model?

33:00I think we give it a half point here just because of all of the interesting alternatives. All right. Well said. I agree. Yasser, what about Duolingo? Is Duolingo free of any disruptive upstarts visibly challenging its business model? If you looked at the price chart of Duolingo over the past year, it's down over 50%, which are completely divorced, by the way, from the fundamental performance of the company on the top and bottom line. And the reason for that decline, stock is basically halved, is that there is so much worry about the possibility of large language models and AI to disrupt the language learning kind of niche in which Duolingo operates.

33:42A lot of people think that Gemini in particular, Alphabet's AI model, can be a player in this area. However, there is no direct competition yet to Duolingo. So I'm going to move us for at least a half point here because I do think AI is a visible challenger that could undermine Duolingo's business model. Yasir, you know this company better than I do. I see you half nodding. You and I, this is an audio-only podcast, but we do see each other over Riverside. and I see you willing to concede at least a half point. Do you think this is a half point or is this a plus one? I would give it a half point.

34:18And the reason is I'm still not entirely sure that there is a viable business model or at least that there is a viable alternative that has come to the surface. Not that it cannot happen, but I see that Duolingo does have some competitive advantages that make it extremely hard to disrupt. And perhaps we will talk about that when we talk about the moat and the questions to come. Let's do that. You're doing a good job leading us forward each time because, indeed, question number 13 in the final in our competition section is entitled Moat. Turning back to Etsy and Alicia. Alicia, would potential new competitors face high economic, technological or regulatory barriers to entry?

35:02No. So there are some barriers to entry in creating the platform and attracting the talent. Right. but we're not talking about something that's terribly capital intensive, like an airline or with lots of regulations like in pharmaceuticals or biotech. Yeah. So that's a no. Therefore, that is a plus one adding to the risk of holding or buying Etsy stock. People can kind of set up their site on Shopify and all of a sudden be selling that same crocheted quilt, possibly crocheted by a 10 month old. And therefore, I think earning a premium because that would be really special. And yeah, that can just happen pretty easily these days globally.

35:40So I hear you on the plus one for Etsy. As we close out question 13, I now have Etsy at 2, 3, 4, 5.5 on our risk rating system. Yasser, what about Duolingo? Would potential new competitors face high barriers, whether economic, technological, or regulatory, to enter its market? I would say yes, there are high barriers to entry. Duolingo does enjoy a significant moat. moat. I would say it's one of scale and as well as network effects. So Duolingo has over 500 million users effectively that provide it with data constantly, which it can use to train its own AI models and integrate AI into its offering.

36:22It has strong brand recognition. But more importantly, I think Duolingo has really excelled at not only teaching language, but making it almost addictive, right? So it's habit-forming, language-playing. There's gamification, there's social network aspect to it. You're checking on other people and how they're doing. You also have your own streak that you must keep alive at all costs. Is it time now for us to reveal, Yasser, your own language of choice on Duolingo and your own streak? And I think it is time. Sure. My language of choice is Italian, and my streak is 1400 days. Sounds like you're rounding.

37:04How many exact days? I will have to open the app for that. Yes, you will. But I think we need to hear it because one of the things I learned when I was bouncing on my daddy's knee is round numbers are always lies. There you go. All right. To be perfectly exact, my streak is 1399 days. Wow. That was really close. and that's quite remarkable and obviously Yasser you're somebody who's got to know this company really well it's always fun learning from an analyst who really knows the product or service well Yasser it's often been said by people that yeah Duolingo is actually just a video game company that happens to use language as its content to drive user interest and activity I've always viewed that of course as a lifelong gamer myself as a high compliment because it really is a beautifully designed set of game experiences that recur, add some variety, and keep people engaged.

38:03Some of the brightest people I know for as many as 1 ,399 days. Exactly. And the best part of it, it's actually free to use. Which is remarkable. I do pay, though, and I'm a shareholder on a side note. It's been disappointing watching the stock because this stock, as you well know, Yasser, many of our listeners probably not keeping up that often necessarily with Duolingo, but the stock touched a high of about 500 last year, less than a year ago. And right now it's about 150. And as you mentioned, part of the story of the stock is maybe a disconnection from the financial results based on worries and fears around disruptive AI.

38:41I think that's accurate? That's absolutely accurate. And David, this is when I get most intrigued and interested in a stock. There's that disconnect between fundamental performance and price action. And, you know, any number of very successful rule breakers that have gone through the years have had drawdowns of 50 percent or more only to to come back and make new highs. All right. Both of these really interesting, sometimes volatile stocks. We've just finished more than half our questions. That was the competition section. And as we enter section number four, which is about the stock, three questions we ask about the stock.

39:17I've counted Etsy at five and a half and Duolingo at two. Let's keep moving. Alicia, question 14 is just market cap, something near and dear to the heart of this show. Number 14 is entitled market cap. Now, that is a phrase near and dear to any longtime listener of this show because the market cap game show is a game show we've made about market cap. The question that we use for our risk ratings, Alicia, for number 14 is, does the stock here, does Etsy have a market cap of more than$10 billion? Yes or no? No, it does not. It's$6 billion. So that's a plus one. This one, straight up quantification.

40:01Why do you think, I mean, any number that you pick for market caps is a little bit arbitrary. Let's just all acknowledge that up front. If you asked two dyed-in-the-wool longtime Wall Street analysts, what is a mid-cap stock? I think you'd get two different ranges. But directionally, why do you think I favor, I realize I'm asking you to intuit what I'm thinking, Alicia, but why do you think I favor$10 billion? Well, I'd imagine it's because it gives you a reflection of a company that's been more established, has been around for a while, and therefore hopefully has a little bit less risk. Yeah.

40:37And none of these, of course, is a single factor decision you're making about a stock. It's all to see the overall body of work here, the 25 questions that we ask. But I think it really is relevant to ask about a company's market cap. Where is it roughly? Because at a certain size, companies are less risky if they have resources, if they're sizable enough to have large customer bases, etc. That definitely lowers the risk at least one twenty fifth of the way. This is one of our 25 questions. Yasser, how about Duolingo? Does the stock have a market cap of more than$10 billion? No, it does not. Its market cap is about$7 billion right now.

41:14And that's, of course, less than half of what it was just about a year ago. Really interesting to follow. So plus one for both of these companies. Let's next move to beta, which is question number 15. Is this stock's beta less than 1.3 over the past 12 months? That's the question we ask. And before I ask Alicia about Etsy, I'll just mention beta for those not familiar. Many longtime investors will be is basically just measuring how volatile a stock is. If a stock moves up and down by about the same amount as the S &P 500 every day, week, month, year, it has a beta of 1.0. If it moves up or down more spasmodically, accelerating on highs, declining further on lows, then it would be an over 1.0 ratio.

42:02So I use 1.3 as sort of a dividing line between more volatile stocks above 1.3 or less volatile. So now with beta a little bit explained and my own bias toward using a certain number. Alicia, is Etsy's beta less than 1.3 over the past 12 months? Yes, it is. It's 0.85. So it moves pretty closely, tracks pretty closely with the overall market. Excellent. And let's turn right back to Yasser now. Yasser, what about Duolingo? The answer is no. The beta has been all over the place over the past 12 months, starting the year at around 1.7, ending the year at around 1.1. But in between about June, July of last year, we witnessed a spike above two and a half.

42:52Wow. Yeah. So, yeah, the answer is no. This is a very volatile stock. And before we move on to number 16, where we're going to look at the price to earnings ratio, I do want to point out that for a lot of market observers, beta is what they use to measure the risk of a stock. They're basically saying it's a risky stock if it's jumping up and down, and it's not a risky stock if it doesn't move much. And obviously, I give a little nod with one of my 25 questions to beta right here, but I don't spend a lot of time looking at beta myself. And I would say risk is much deeper than just looking at how volatile a stock is.

43:30So this is one of my favorite ones because I like to double underline this point, especially for people new to thinking about risk and what is medium risk or high or low risk for stocks. That's why I love numbers, not just labels. And in a world in which people tend to use a single number, the beta, to estimate how risky they think a stock is. And as a wise man once said, volatility is a price of entry for outsized returns. Well said. And that's actually... That wise man being you, David. Well, that's kind of you. I think Aristotle said something like that. I'm sure Morgan Housel has a great line about that.

44:08So yes, I will not accept any personal credit there, but thank you. I do think that volatility, especially for rule breaker stocks, is going to come with the territory. Not everybody who listens to this podcast from one week to the next is necessarily searching rule breakers or would say that they are a dyed in the wool rule breaker investor. But it is worth pointing out that for Classic, our biggest winners, those seven plus 100 baggers that I've picked in the past. Yeah, they got cut in half more than once. And you had to sit there on your hands and watch it happen if you really wanted to earn crazy good returns.

44:42Let's move now to question number 16. As mentioned, it's entitled P.E. ratio. Here's the way I phrased it. Yes or no, Alicia? Does Etsy have a positive price to earnings multiple that is less than 30? No, it's 39. And that's pretty expensive when you compare it to something like eBay or Amazon, though it is cheaper than Shopify's. I believe it's 115 times the last 12 months earnings. And for Etsy itself, that's actually not the worst valuation that we've seen. That was back in 2020, and it averaged just under 100 times price to earnings. Which is quite remarkable. And, you know, I will say as a rule breaker investor, I'm not afraid of high P.E.

45:28ratios. I do believe much of the world is trained to think that you would never want to buy a stock with a P.E. ratio, let's say, of 50 or higher than that, certainly. And yet some of my best stock picks had even higher P.E. ratios than that and went on to become 100 baggers. Intuitive Surgical is one example. So I personally am not afraid of high P.E. ratios. But with that said, we're examining the risk of stocks, Yasser. And here, you know, a higher P.E. ratio is naturally going to add to the riskiness around a stock. If that company comes out with disappointing earnings or a surprise number, that stock will get hurt more to the downside than many other companies with lower P.E.

46:09ratios. Yasser, how about Duolingo? Does Duolingo have a positive P.E. multiple less than 30? So the answer is yes, but, right, so technically it did have a 19 times PE ratio for the last 12 months. However, again, as I alluded earlier, there was a one-time tax benefit that DualEGO benefited from in the last quarter, which really did impact how these results can be construed. And therefore, I think in this case, it might actually be more instructive to look on a forward basis, forward-looking basis. Okay. So it trades at 38 times next 12 months PE. And therefore, I don't know if you want to give it half a point or a full point.

46:49Let's give it a full plus one there, just because I do like to generally remain true to the system and not scatter a whole bunch of half pointers everywhere. But that's just my own stylistic leaning. I could easily imagine people who like more nuanced stuff going, well, that's actually a three quarters of a point or just a dot two five. But let's go with a straight classic plus one because the company does not have a PE multiple less than 30. And by the way, I always say, does it have a positive price to earnings multiple? Meaning you want to have earnings. That's going to lower the riskiness of a stock.

47:22And so it is always a positive PE multiple that is less than 30. Well, thank you both. We've just closed up the stock section. And by my counting, we now have Etsy at seven and a half and Duolingo at five. Let's move on to questions number 17 and 18. This is about the people, something that matters greatly to Rule Breaker investors. And two questions are dedicated to looking at what some people term the human capital of a company. Let me turn to Alicia. This one, number 17, Alicia, is entitled Founder. Do any of the key Etsy insiders still have at least a 5 % stake in the company? No. So today, the lead independent director, the former CEO and executive chair, the former CFO, and the current CEO combined own just over 1%.

48:14To be fair, that is a fair amount of money. It's something like$64 million, but yeah, not 5%. Yeah. And so not even close to having any key insider who really, really feels strongly the weight up or down of the performance of the stock. And again, this doesn't on its own mean it's a great stock or a very bad stock. It's just part of the overall panoply, part of the overall view that we take of companies. And at least in the case of Etsy, we don't see anybody who's founder-like a significant stakeholder. And Yasser, how about Duolingo? Any key big stakeholders among insiders? Yes. So both co-founders, Luis Von Ahn, who's the CEO, as well as Severin Hacker, they each hold significant stake in the company.

49:03Luis Von Ahn owns approximately 7.1%. Severin Hacker owns about 6.5 % of the company. So they are well above the 5 % threshold. And Yasser, why do you think we even include this in our risk rating system? What does it mean to have significant stakeholders active at a company? So to borrow a phrase that our CEO, Tom Gardner, likes to use, we like CEOs who have skin in the game. We want to know that the CEO, the operators, they care about the company. They are fully invested in the company. They want it to succeed and therefore will shepherd it in that direction. Very well said. All right, let's move on to one more people question about risk.

49:44Number 18 is entitled tenure. Alicia, do the top three officers at Etsy have more than 15 years of combined leadership at Etsy? Yes. So I would say they have more than 15 years of combined service. So the new CEO has served in different roles at Etsy since 2011. The CFO has been there a year and the chief product and technology officer has also been in Etsy for several years. It's nice to know. And yes, that's certainly in my mind going to reduce the risk profile of a company. If you have people who've been around, been there, done that, institutional memory, and presumably haven't been fired for incompetence, they're still there working, even if their stock is volatile or hasn't been awesome the last few years.

50:28Yasser, how about Duolingo tenure? Do the top three officers at Duolingo have more than 15 years of combined, I like Alicia's tweak there, of combined service at the company? Yes, easily. So just the CEO on his own has about 14 and a half years of experience or service at Duolingo. And the average management tenure is around six years. Recently, they replaced their CFO and the new CFO actually came from the board. So she already had been serving at the company for many years. So yes, easily they surpassed that. Wonderful. Those are our two questions about the people. And my ongoing tally suggests that Etsy is at eight and a half and we have Duolingo at five.

51:33Green Flag Alarm. Make now close with your old phone number and get you until the 17th of February your new favorite deal on Spasim.de.

52:03going to go through them one at a time. The first one is called the Stock Advisor Way. And because I initially use this system a lot for Motley Fool Stock Advisor, we like to say, what do members who use Motley Fool Stock Advisor kind of expect to see? What fits well with Motley Fool Stock Advisor? And I would then say, if we could say yes in answer to this question, we would say that company's less risky. If we give it a no, just like any of the other questions we're asking, we'd say that's a little riskier. So 19 is the Stock Advisor Way and 20 is about conscious capitalism, something that recurs frequently on this podcast.

52:38I know we have new listeners all the time. If you've never heard this funky phrase, conscious capitalism, feel free to Google it or go to consciouscapitalism.org and you'll learn more or just read chapter four of my book, Rule Breaker Investing, where I say that's one of the habits we need to develop as investors to follow the tenets of conscious capitalism. Anyway, that's number 19 and number 20. So Alicia, let's go now with Etsy. And the question, the Stock Advisor Way question we phrase this way, is this a solid business with proven management and a stalwart balance sheet? And the reason I use those words is because that's often what we think we're promising when we make a new Stock Advisor pick.

53:22Whoever's making the pick at Stock Advisor from whichever team. And we realize there's a motley array of different kinds of companies, but we think most of our stock advisor members like things like solid business, proven management, stalwart balance sheet. What about Etsy? I'm going to say no here. I have a lot of questions on the business. As I mentioned before, gross merchandise sales are decreasing. As for the proven management, so we have a new CEO, though she has been with the company for many years and also served as CEO for Etsy's other company, Depop, which again is that online marketplace for clothes.

54:00I am interested to see what direction she takes the company, but it hasn't been very long. So I can't say there's proven leadership here. As for the balance sheet, I mentioned this earlier,$1.5 million in cash and short-term investments, but also nearly$3 billion in long-term debt. I'd like to see more cash than debt to be able to call a balance sheet stalwart. So we're going with no here. A no is a plus one in our system. So plus one, I realize like plus one is cool in a lot of other contexts. People like plus one, plus one, that comment for what we're doing here. Plus one means riskier stock.

54:35The higher the risk rating, the higher the risk of the stock. So plus one for the stock advisor way, because Alicia says no on Etsy. Yasser, how about Duolingo? Is this a solid business with proven management and a stalwart balance sheet? It is absolutely a solid business. It has been growing profitably over the past three years. You know, it has strong balance sheet, over$1 billion of cash. It is led by what I would consider a visionary co-founder and Luis von Ahn. He's been at the company for, as we said, 14 plus years. strong track record of growth, innovation. And yeah, so all in all, the answer is yes.

55:14A solid yes for the Stock Advisor Way and for Duolingo. By the way, this little section, Stock Advisor Way and Conscious Capitalism, I call go-tos because these are kind of go-to questions. We're really hitting at the heart of what we're seeing when we look at this company and think about the highest ideals of what we want to see, solid business, proven management stalwart balance sheet. And for me, conscious capitalism counts deeply too. Well, at least one 25th of the way they're toward estimating risk around any stock. Let's now go to conscious capitalism and Alicia, and let's talk about Etsy.

55:51Here's the question, Alicia, is management looking out for the interests of all stakeholders, which would be, for example, customers, of course, employees, shareholders? This is one of those qualitative questions. Alicia, what do you think when it comes here to Etsy? I would give them half credit. I think for the most part, though, they can probably be better. I think that where they're getting dinged here would be the sellers. And it's because they increased the toll that they take from its sellers. And I'd imagine as a seller, that can be pretty frustrating. So they have transaction fees, payment processing fees, listing fees, other fees.

56:28And then if you want advertising, there's fees for that. But at the same time, it does give sellers that platform to be able to find buyers, even if you're just starting out and you're a really small business. I think that's really important. I think in terms of buyers, having the value proposition of being able to find a unique item in the marketplace, I think is good. But for shareholders, buybacks probably make some of these shareholders happy. I've talked about my concerns with it because I think that cash can be used elsewhere. I like it. Half a point. So we want to be able to say yes every time and not add any risk at all.

57:08But a half point here for Etsy. Yasser, how about Duolingo in the area of conscious capitalism? I would say yes. So Duolingo, it starts with the mission, really. I mean, the mission is to make education here free and accessible for everybody, which does benefit the user. Anybody can download an app, can start learning a new language or a new skill like math or reading or piano, you know, music. So there's a lot that Duolingo offers and a lot that it offers for free. Now, importantly, the CEO has been making it almost his personal cause to continuously offer more value to the user over time without necessarily charging everything upfront.

57:51The last part is, I don't know if you follow Luis Von On on LinkedIn, but please do yourself a favor and do. Okay. Because he's constantly talking about his employees and the culture at Duolingo and all the ways Duolingo is working to make everybody who's based in their headquarter office in Pittsburgh, by the way. Okay. And he talks about the fact that they refuse to move to Silicon Valley. They want to stay where they are. And the fact that they give, for example, their employees' full two-week break during the holidays. So for Christmas, New Year's, two weeks off, nobody shows up to the office.

58:27Everybody has to switch off. Wow. I love that. I love that about him. And it shows a great deal of conscious capitalism. It's an American city that lost its NFL head coach very recently, but has retained the corporate domicile of a major player in the greater city of Pittsburgh, Pennsylvania. That's That's really cool. I did not know that. Okay, well, by my tally, as we enter the home stretch here, our final five questions. Right now we have Etsy at 10 and Duolingo at 5. Let's now move to the final five. Since this is The Motley Fool, these are my Motley Fool friends, analysts, and advisors, geniuses.

59:03The last section is, of course, foolishness, because how could it not be? So the last five sections I categorize under sort of a motley category that I like to call foolishness. And there's a trick to a few of these, and I'll just put it out there up front. So questions 21 through 25 are foolishness, and 21 itself and 25 itself are intentionally designed so that you can only answer no. That is, it's going to add to the risk of a company. And why is that? Well, it's because I didn't want to design a system where if you answered yes all the way through, you ended up saying, oh my gosh, the risk of this company is zero.

59:46And that doesn't make any sense to me because of course, just crossing the street in life has some small measure of risk. So I intentionally rigged it so that questions 21 and 25, we'll do 21 first, are no. I'm not trying to telegraph your answers. Alicia and Yasu, you can disagree if you want, but let me turn to Alicia. Number 21 is entitled Immaculate with a question mark. So it's entitled Immaculate. And here's my question. Alicia, is Etsy certain to be fault free and fraud free in all its corporate statements and deeds? Yes or no? I'm going to go with no here, David. And why would you go with no?

1:00:31Well, I mean, it would be lovely if we could be certain of these things. But as you said, you know, there is always going to be risk in investments. And what I like about this question and your question 25, which I think people will also enjoy, is this really encapsulates the fact that there is always going to be risk. You cannot be certain that a company will be fault free and fraud free for all time. Not possible. I wish it were. I wish it were. But no. I do, too. And some of my worst stock picks ever were companies that were highly esteemed at the time. I'll give a quick example. Krispy Kreme Donuts.

1:01:08I really like Krispy Kreme. And it's a beloved brand and a business that grew up in Winston-Salem, North Carolina, a city I know pretty well. And it was public and very successful for a while until we discovered that there was a little bit of chicanery going on and how they were scoring store openings and the value of franchising. And all of a sudden, I watched my Krispy Kreme stock pick for Motley Fool Stock Advisor lose more than 90 % of its value. A shocker. And one I'm still a little sad about. Companies kind of come back. Management got replaced. But you would have thought, surely Krispy Kreme beloved brand donuts, clearly this is going to be fraud free.

1:01:53Maybe not even quite fault free, but clearly. And it turns out I was wrong. So thank you for that, Alicia. Let me now turn quickly on this one to Yasser Yasser. Is Duolingo certain to be fault free and fraud free in all its corporate statements and deeds? No, you can never be searching for any company to be fault free or fraud free. That's always a risk that we're going to carry as investors. Thank you. Plus one for each of those. No is the answer to question number 21. Number 22 makes its own separate point. What I like quite a lot, it turns the question back to the questioner. It actually asks each of us as we look at the stock.

1:02:34So I'm going to ask Alicia her personal feelings here about Etsy. I'm going to ask Yasser his personal feelings about Duolingo. And you, dear listener, whichever stock you're researching, owning, thinking about, this is for you. And that's why question number 22 is entitled you. Here's the question. Do I want to know more about this company? Am I willing to dig deeper, learn more, and ask questions on the discussion boards to actively try to understand this company? So it's a personal reflection. And of course, my point here, and I'm quite serious about it, is if you say yes, then that's not as risky a stock for you because you are interested in it.

1:03:20You probably already know quite a bit and you want to know more. You are literally lowering the risk of that investment for yourself. And if you say no because it's your buddy's pick or somebody in your investment club said this is a good company, but you're not actually going to study it more, that's a riskier investment for you. So you is number 22. Alicia, what is your answer in regards to Etsy? My answer is yes, although perhaps not for the normal reasons. I find businesses in general interesting and exciting. Etsy in particular, I think what's been fascinating is the fact that they were a pandemic darling and how much they've fallen since then.

1:04:02Sometimes we can find interesting opportunities in companies that were former pandemic darlings, sometimes not. Sometimes where they are is completely earned. I also like to study them so I can understand patterns for the future so that I can see things when I look at the next company and say, okay, I've seen this before. And then what does that mean? Very well expressed. Pattern recognition, such a rule-breaker-y thing. Well said, Alicia. Thank you. Yasser, based on the interest, I might even say passion, and we can count the days if you like, 1 ,399. And I'm guessing, I think I know the answer to this question, but I'll still ask you, Yasser Elshimi, do you want to know more about Duolingo?

1:04:48Are you willing to dig deeper, learn more, and ask questions on our discussion boards if you like to actively try to understand this company? I do and I am. I was a Duolingo user before I became an investor. and that obviously speaks to like the interest I had in the company and the fact that I was satisfied as a user to the point where I came to view the company favorably and therefore consider investing in it. So we always look forward to learning more about companies which intrigue us, which interest us and Duolingo is that kind of company for me. And I'm glad to hear that and I personally am not really surprised that you both said yes to this because when I asked you what company you'd like to bring to our risk rating discussion this week, you brought one of your own choice.

1:05:32So I think that's a great check in the question number 22, you question. But as we now move on to numbers 23 and 24, which have their own mini game going on, I do just want to underline one more time, dear listener, fellow fools everywhere, you're going to have less risk in your portfolio if you populate it with stocks that interest you, companies that you know, or even if you don't know that much because, my gosh, technology, everything's changing, new stuff's coming out. If you're interested, interested to learn more, you really are lowering the risk of any investment you're making. And if you don't feel that way, it doesn't mean never buy a flyer stock or something crazy.

1:06:14Maybe it's fun, but it's definitely riskier for you, isn't it, if you don't really know much and aren't willing to learn more. All right. Triple underlining number 22 here as we move on to the pair, numbers 23 and 24. So I'm just going to read out the question that I've sent to both Alicia and Yasser. Question numbers 23 and 24 sound very similar. Let me just go ahead and read 23 right now. Here it is. Write, or we might say ask, the single best, most beautiful and illuminating question you can about this company and answer it. Yep, that's number 23. We're inviting you, the listener, you the stock researcher, to add your own question into our framework.

1:07:01And this is an opportunity for you to think outside of the normal bounds of the financials, the people and other sections here and just thinking, what is the most creative and important and maybe fresh question that you could ask about this company? And question number 24, by the way, is what is the second best, most beautiful and illuminating question you can ask about this company and answer it? And we're just going to do that. And then I'm going to make a quick point about why we do that after we do it. So let's go to custom question number one, number 23. Alicia, what is the single best, most beautiful and illuminating question you can ask about Etsy?

1:07:41And please answer it. Well, I have stolen this question from you. So this is actually from our penalty box question or questionnaire, if you'd like, which goes through and tries to determine, hey, how is this company doing? Should we box it? So this question is, purpose. Can you reaffirm the true importance and value of this company, what it provides to today's real world? Yes, I can. So it's important because it allows artisans a place to sell their items and reach a huge audience of buyers. For buyers, it allows them to find unique, vintage, handmade, and customizable products. I think that is a great question to ask about this company.

1:08:23It's purpose here. Of course, I think purpose matters a lot for every company, but some of them matter more to the company than others, especially smaller companies. If they have bigger purpose, that's a really good sign. Some really big companies don't seem particularly purpose driven to me. Not so good a sign, in my opinion. Thank you for that. And the way that you answered it was a yes. So not a plus one, a yes, keeping it at zero. Let's go now, number 23 to Yasser, asking his best, most beautiful and illuminating question about Duolingo. So my question is going to be hopefully illuminating.

1:08:59I don't know about beautiful. That might be too much to expect here. But my question is, is Duolingo's moat defensible against free AI-powered language tutors? And my answer is yes. I would say investors have a right to worry about this. We can definitely see that reflected on the price chart. However, I do think that people use Duolingo not simply for language instruction. And I think that's probably the part that the market is missing and where the disconnect is. The market thinks that if an AI model comes up with a program or a model that helps you learn a language perhaps more efficiently, then you're going to go with that as opposed to Duolingo, completely ignoring the network effects, the benefits of scale, as well as the gamified experience and the social network-like experience that users have?

1:09:48So my answer would be yes. I think that is a beautiful question. I know you said it may not be beautiful, but at least in Warren Berger's words, author, former guest on this show, his wonderful book, A More Beautiful Question, that is a beautiful question. And it is obviously at the heart of the investment scenario right now, a stock that we find less than half where it was a year ago. And yet the company seems by most measures to be doing quite Well, thank you very much. And so really, that does hit right at the heart of the investment scenario. And I agree with you. I'm a bull. I'm a shareholder as well.

1:10:20And so I appreciate you thinking the social network like people send stuff to each other, little gifts and encouragements and that kind of social capital which exists in the app. I'm not sure I see an AI, possibly sterile AI experience coming along and really heavily disrupting that. And for the market to be repricing the stock in such a way that that seems very fearfully evident or possible, I disagree with that a little bit. So we'll see, though. Great question. So that was both Alicia's and Yasser's best questions about their companies. And if I heard it right, that was a yes to both. So no plus ones there.

1:10:57Let's go now to question number 24. Then I'm going to want to make a short point about why we do 23 and 24. But back to you, Alicia, what's your second best, most beautiful, illuminating question about Etsy? It's again from the Penalty Box questionnaire, which I feel like perhaps one day will have its own show, its own episode. Thank you. Let me jump in quickly, Alicia, because not everybody understands what you're saying. And I want to make sure everybody does. So we have services to the Motley Fool. We hope you love them. We hope you're signed up for them, dear listener. You can start with Motley Fool Stock Advisor.

1:11:30That's our cheapest, broadest service. A lot of people get started there. We have many different types of services. The ones that I historically worked on, we created something called the penalty box, where we would take a stock and we would say to members, we don't like it right now. That doesn't mean sell it. Just like in NHL hockey or hockey at any level, we're sending it over to the penalty box. We're taking it off the ice. We don't think it's good for new money now, but we're not selling it. And I tried to design a tool in a questionnaire that would help us internally decide when should we penalty box of stock and when should we not.

1:12:04And so, Alicia, you're you are alluding to what we use internally, which I've sometimes called the boxometer. And and some of the questions that we like to ask there. Or the box-o-matic. I think I've also heard it called that. Oh, my gosh, you're right. I'm rebranding my own creation. No, it is the box-o-matic. OK, Alicia, what's question number 24 here for Etsy? Can I just tell you, I think both words work. So the next question, and for the penalty box questions, I think that they're really helpful in analyzing a company, asking the questions to help you understand where the company is at now, which is especially helpful for these former pandemic darlings.

1:12:43So the question that I have stolen from you again is, does this company have any identifiable positive near-term catalysts? My answer here is, I'm not sure. Half a point. Certainly economic uncertainty, tariff headwinds can be a catalyst in the wrong way. The company is also making investments in AI, using AI to improve things like estimated delivery dates and making seller items discoverable through ChatGPT. It's also creating tools for sellers like listing title suggestions, writing assistance to help with communications with buyers. That's all interesting. But is it a catalyst? I'm just not sure.

1:13:26I like the question a lot. And I think a half point answer, which has become a theme of this particular episode of calculating risk foolishly. And I like that it is. I think you've innovated here, Alicia. I'm sorry. Let's give it a point five. So adding a half point. I believe that brings us to Etsy is now at 11 and a half. We're not quite done. Let's, though, turn first to Yasser for his second best question here about Duolingo. So my second question for Duolingo is, can Duolingo successfully expand into other verticals beyond language instruction? And can they be profitable and successful? Great question.

1:14:07So like Alicia, I'm going to give a half a point here. I would say Duolingo has already launched new verticals, including in mathematics and music, introducing a standardized English exam, for example. However, it's still early days. There's not enough evidence to suggest that these verticals have necessarily, you know, lit the world on fire or been wildly successful or that are adding meaningfully to the company's bottom line. So this is a case of wait and see. And, you know, I did reference it briefly earlier because I've definitely heard about it multiple times now. I haven't used it because I'm not a big chess player myself.

1:14:42I like a lot of other games, Yasser. But I would say there does seem to be some buzz around Duolingo chess, at least in the circles in which I move. Do you feel the same way or not? My eight-year-old just started learning chess on Duolingo. So I'll keep you posted. It's interesting. And again, I really like the question that you're asking. And while we can't with certainty answer yes or no to that one, the important thing is we're asking questions that matter. That's why we're saying, what is the best question? What's the second best question you can ask? And if I may add here, David, like one of the questions that I always ask myself, And this is the case because I almost always veer towards growth companies and growth stocks.

1:15:23And that question is, what is the next S curve of growth going to come from? Right. So we know that they are doing this thing, whatever they're doing very well. But where is the next curve of growth going to come from? And I love companies that are able to introduce new verticals and then grow on those verticals. Go with the companies that can open up more and more options for themselves. I really appreciate that as well. Well, let me mention a little bit briefly about questions 23 and 24 and why we craft them this way. First of all, I think every company, every stock is unique. And so I don't think a single set of questions that unyieldingly repeats itself in every context is as valuable as a framework that has a little bit more flexibility that opens up possibilities.

1:16:13And you could ask special questions in special situations. So that that's the purpose of numbers 23 and number 24. But it also having fun with this, it also lets you cheat. And here's what I mean. By inviting Alicia and Yasser and you, dear listener, to craft a question of your own and then answer it, you may have noticed you can actually phrase the question in whatever way you want to obtain the yes or no that you may desire. And the reason I designed it that way is because sometimes my professional analysts at The Fool get to this point and they're like, wow, I'm just making this up. it's a 12, I actually think that's riskier than it really is.

1:16:58In that case, that person should, with the two questions, intentionally phrase them so they're answered yes. That way, the risk rating doesn't increase further. The opposite is also sometimes the case. You're like, wow, we're at a certain number, six. I think the stock's riskier than that, though. So in that case, the researcher would want to ask the questions in such a way that you answer no and plus it up from six to eight. So very intentionally, it's allowing in part the questioner to guide the number a little higher or lower based on the nuance and context that they themselves have or bring.

1:17:34And I realize not everybody even feels that confident or knowledgeable to know where they think the number should be. But as Alicia said earlier, we're learning pattern recognition with a framework like this. The more you use something like this, the more you can see the patterns that will help you recognize better where risk is and sometimes where risk isn't. So that is the intention of custom questions number one and two, which brings us now to the final question. And spoiler alert, we already know this one, but I'm going to turn to you first because you already know what the answer is. And so do our listeners if they're listening.

1:18:08Question number 25. But it is kind of fun. So here it is. I'm going to ask it anyway. Alicia, this one's entitled Bulletproof. It is the final question we ask in our 25 point risk rating system. Alicia, can you be certain in this case that Etsy is invulnerable to external world or macroeconomic events such that you're sure you can get all your capital back? Yes or no? Absolutely not. Nothing is invulnerable, not even Superman.

1:19:06Yes, as you already know, Alicia, I didn't want to design a system where people would say risk rating was zero for that one. So this ensures 21 and 25 that the minimum risk rating will always be two. And I like that. Most risk ratings are higher than two. To have said yes to the other 23 questions is quite a remarkable situation and yet worth keeping an eye out for. Yasser, let me ask you about Duolingo. I know you're a bull. I know you're a share owner. I think you're smart. I hope you're right. The sucker's bouncing back, but we'll see. Yasser, can you be certain that Duolingo is invulnerable to external world or macroeconomic events such that you're sure you can get all your capital back?

1:19:49Absolutely not. I mean, investing always carries risk with it. And I would not describe any company with the adjective bulletproof. Things happen. And in this case, they could be disrupted by AI. There could be key insider risk if for any reason the CEO steps down or leaves the company. You know, there just could be any number of scenarios according to which Duolingo may not do well in the future. Very true. True of Duolingo, true of Etsy, true of meta platforms, true of Netflix, true of IBM, true of whatever your favorite microcap crypto play is. True that. Well, again, I want to thank Alicia Alfieri and Yasser El-Shimi.

1:20:33This will be one of our longer podcasts of the year, and it should be. We do this once every two years. We take you, dear listener, through two companies, through 25 important questions in order to get to a better place than, yeah, it's a medium risk stock. I hope, again, with the help of our friends, your understanding of Etsy, ticker symbol E-T-S-Y, and of Duolingo, ticker symbol D-U-O-L. I hope we've contributed to your overall understanding of these companies, but more broadly, to think about risk as an investor in any company you're researching. You know, what we're really doing with this system is, I think, this was pointed out after our very first episode on risk ratings done in 2016 on this podcast.

1:21:18One of our listeners said, you know, actually, I've been charting your risk ratings, and I think it's actually just scoring the quality of companies. And he said, based on my early studies, a listener named Tom said to me, I actually think the lower rating companies generally do better as stocks. This is a little reward for those who've listened all the way through this podcast to us, because I started off by saying we're just looking at risk here. We're not saying that this or that number or stock is better than another. But I would also say part of my own learning has been that what looks like lower risk companies and people say low risk, low return, high risk, high return.

1:22:01As a rule breaker, I disagree. Part of my learning is that you can find lower risk companies with some of the highest returns available on the market. So that is my rule breakery point at the end. All right. Well, thanks again, Alicia. And how about a final thought on Etsy? Yeah, I would say Etsy, former pandemic darling, still a lot of questions around it. Really well said. We asked at least 25 of them this week. Yasser, how about a final thought from you on Duolingo? Sure. With almost 1400 days streak of Italian, I'm getting pretty tired of it, honestly. So I want to start a poll. Maybe our listeners can send me nominations of which language I should learn next.

1:22:47Excellent. Are you TMFProf on Twitter? Yes, I am. Excellent. At TMFProf, I hope you get some suggestions as to which you should pursue next. My understanding, Yasser, were you studying all this before a trip to Italy? No, actually, I wasn't. It was completely because I love the language. I watch Italian movies. I watch Italian soccer. Obviously love the food. So just to be able to interpret a good spaghetti western, you just wanted to nail it. All right, good. Well, thank you again to Alicia and Yasser. And to you, dear listener, Fool on. As always, people on this program may have interest in the stocks they talk about.

1:23:24And The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. Learn more about Rule Breaker Investing at rbi.fool.com.