The Xero Limited (ASX: XRO) share price has been on a steep upward trajectory in 2019 with shares up more than 50%. Here 2 reasons why it may not be too late to buy.
The Xero Business
Founded in New Zealand in 2006, Xero has become the dominating player in the business and accounting software market in Australia, New Zealand and the UK. Employing more than 2,300 people, Xero helps more than 1.8 million subscribers manage their accounting and tax obligations.
Rapid Growth Leading To Profits
Xero has been rapidly expanding its customer base both here in Australia and abroad. Total net subscriber growth was in excess of 400,000 in FY19 with more than half of that being made up by customers outside Australia.
Revenue was up 36% in FY19 and gross profit was up 39%. The company also generated positive free cash flow for the first time in its history, a very important milestone that indicates the payment of a dividend may not be too far away.
What stood out most of all in the 2019 results however was the fact that the company recorded a net profit after tax for the second half of the financial year. Given high operating margins once the business has crossed over the line of profitability, any increases in revenue will quickly drop to the bottom line.
With the ability to grow profits very quickly, a seemingly sky high price-earnings (P/E) multiple can be made to look irrelevant in a very short period of time. In fact, the P/E multiple is an especially poor valuation metric to use for Xero and can easily mislead investors.
Superior Product Offering
The main reason for the rapid growth of the Xero software is that it is a high-quality product which simplifies the lives of business owners all over the world.
The software allows for a more efficient and cost-effective way of performing administrative duties to do with the day-to-day running of the business, such as issuing invoices and performing more advanced bookkeeping and accounting duties.
With Xero software accessible from anywhere at anytime via the cloud, it provides business owners and their accountants more flexibility than ever before.
The emergence of Xero as a powerhouse in recent years has had a negative impact on the share price of Reckon Limited (ASX: RKN), which has seen its share price fall from over $2 a few years ago.
Am I Buying Xero Shares Now?
Whilst I concede there are even more reasons to like Xero than what I have mentioned above, I am unwilling to pay the current asking price. So much future growth is already baked into today’s share price and I would need to see a decline of at least 10% before seriously considering adding Xero to my portfolio.
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At the time of publishing, Luke has no financial interest in any companies mentioned.
