I'd prefer to own XERO FPO NZX (ASX: XRO) instead of Woolworths Limited (ASX: WOW) at today's prices. There are a couple of key reasons for this:
- Profits
Xero has around an 85% gross profit margin, while Woolworths' margins are around 29%. This is because they're totally different businesses. However, it's illustrative to think that it's approximately 3x as easy for Xero to grow profits compared to Woolworths. If Xero makes $1 million in new sales, $850,000 dollars of that is kept as gross profit, after the costs of making those sales is subtracted. For Woolworths, the figure is just $290,000.
- Growth
Partly because of its margins, and partly because it is quite early in its business life, Xero has plenty of opportunity to grow, both in its existing markets and new markets like Singapore. Woolworths' only has a limited number of areas in which it can build new supermarkets, and it is quite hard to repeatedly invent new products that will lead to millions in new sales. Woolworths will find it much more difficult to grow, and its growth is much less rewarding than Xero's.
- Capital Intensiveness
It costs a lot of money to build new stores and invest in manufacturing new products. Woolworths has billions tied up in its stores and inventory, and it must spend millions to generate new sales. Xero on the other hand, can grow for relatively little cost once its product is developed. Additionally, Xero customers tend to stick around for several years, resulting in a lot of repeat business, unlike supermarket customers.
To be sure, it's an apples and oranges comparison between the two, and Xero's positive attributes are priced into it by the market. Xero would be totally unsuitable for a retiree looking for income to live on – not least because Xero doesn't pay a dividend. But as a young investor, these attributes go a long way to explaining why I own Xero shares instead of Woolworths.
