The Xero Ltd (ASX:XRO) share price is up 29.4% since the start of 2024. Let’s take a look at why investors might be interested in XRO shares.
XRO share price in focus
Xero was founded in 2006 in Wellington, New Zealand, by Rod Drury, who led the company until 2018. Employing more than 3,000 people, Xero helps millions of subscribers manage their accounting and tax obligations across the globe.
The cloud-based “beautiful accounting software” developed by Xero is primarily for accountants and bookkeepers to better service their small business customers.
Through Xero, small business owners and their advisors/accountants have access to real-time financial data and on any device. Xero provides its core cloud accounting software to customers in New Zealand, Australia, the UK and, to a lesser extent, the USA.
The case for ASX tech shares
The S&P/ASX200 Info Tech Index (ASX: XIJ) has returned 14.49% per year over the last 5 years. That compares to the average of all ASX sectors of 4.41% over the same period. So, here are some of the reasons that investors have been flocking to ASX tech shares.
High Margins
Technology companies tend to have much better margins than more ‘traditional’ brick-and-mortar businesses. That is, they tend to be more profitable.
The simple reason is that they usually have low marginal costs (like distribution costs) and low overhead costs (things like plant and equipment).
In their last annual report, XRO reported gross margins of 88.20% and an operating margin of 15.10%.
Recurring revenue
The second reason is that a feature of many tech companies is their recurring revenue. You’ve probably heard the term ‘software-as-a-service’ (SaaS) – this is when companies package their software as a service that customers pay for access to on a monthly or annual basis.
This is a great alternative to selling your software as a product (a one-off payment) because it can smooth revenue across the year and make profits more predictable over time.
Global scale
The third reason investors love tech businesses is because of their global reach. If you have a brick-and-mortar business or sell physical products, your potential customer base can be limited by reach, regulation, or logistics. For example, if you sell food items, trying to sell into a foreign market means dealing with packaging rules, biosecurity regulations, and tariffs or quotas.
Software on the other hand can usually be downloaded by anyone with an internet connection at the click of a button. It’s easy to ‘move’ across borders, opening up markets that may not have been available to a product-based business. Basically, a bigger customer pool tends to mean more customers.
XRO share price valuation
As a growth company, one way to put a rough forecast on the XRO share price could be to compare its price-to-sales multiple over time. Currently, Xero Ltd shares have a price-sales ratio of 14.24x, compared to its 5-year average of 18.65x, meaning its shares are trading lower than their historical average. This could mean that the share price has fallen, or that sales have increased. In the case of XRO, revenue has been growing over the last 3 years.
Please keep in mind that context is important – and this is just one valuation technique. Investment decisions can’t just be based on one metric.
The Rask websites offer free online investing courses, created by analysts explaining things like Discounted Cash Flow (DCF) and Dividend Discount Models (DDM). They even include free valuation spreadsheets! Both of these models would be a better way to value the XRO share price.
