Xero Limited (ASX: XRO) is a provider of online accounting software for small businesses. Xero’s mission is to rewire the small business economy, connecting millions of businesses to their banks, advisors and each other.
If you had purchased Xero shares 6 years ago, your initial investment could have been 10 times higher. Since 2012, the Xero share price has increased from $4.65 to a recent all-time high of $47.81.
Xero’s share price performance is largely reflected in its revenue growth. In the last six years, Xero has increased revenue from $31.3 million to $406.6 million. Despite this extraordinary growth, Xero has failed to record a profit since its listing on the ASX.
Since 2012, Xero has posted $276.7 million in losses and with a market capital of $5.43 billion, you’d be right to question the valuation. However, Xero appears poised to deliver profits having executed an effective market disruption.
Market disruption companies are often associated with loss-leader type business models and Xero has been no different. However, with profits on the horizon, Xero’s losses can be justified.
With the investment of $118.8 million into product design and development whilst essentially purchasing market share with $193.9 million spent on sales and marketing, shareholders have reason to be comfortable that their losses will be returned.
Given the scalability of Xero, this level of expenditure is reasonable considering the levels of recent growth. Subscriptions have increased over 300% since 2014 with over 1 million subscribers.
Despite this exponential growth, the current share price of $45 is suggesting there’s more to come. An extract from the 2018 annual report states that the next 18-24 months will deliver “continued strong growth for the core business”.
In agreement, Morgan Stanley whacked a $50 share price target on Xero which means that there is currently 12.6% upside if you agree with this growth sentiment.
However, is this providing enough margin for error?
Xero has previously been placed under high growth expectations. From October 2013 to March 2014, Xero’s share price improved from just over $15 to just under $42. Subsequently, the share price fell back to under $15 in October that same year.
Due to its lack of profits and expectations underpinning intrinsic value, Xero is subject to fluctuating opinions and consequently a volatile share price. I believe in Xero as a business but will wait for the market to offer a discount.
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Motley Fool contributor Matt Breen has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Xero. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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