The Motley Fool

Are Xero shares in the buy zone?

Shares of Xero Limited (ASX: XRO) have taken a very cold shower, with XRO stock down about 6% just today – closing for $59.97 this evening.

Xero has been one of the outperforming WAAAX stocks in 2019 so far. Xero started the year trading for $41.05 but as of last week, XRO shares were knocking on the $66 per share level – a YTD gain of 60%. Even with today’s price drop, Xero is still looking at a yearly gain of 46%. So why is Xero lighting up the market? And (more importantly), is Xero a buy at this new discount?

Why have Xero shares hit the roof this year?

If you weren’t aware, Xero offers cloud-based accounting software to businesses and individuals on a subscription basis. Rather than buying the software outright (soo0o early 2000’s), customers pay to ‘rent’ the software on a monthly basis over the internet.

The company has a ‘status’ advantage as a WAAAXer – us Aussies love a home-grown tech company that takes on the world, especially a Software-as-a-Service (SaaS) one. This places Xero at a pricing advantage – investors usually like to lend some leniency to this type of company regardless of its bottom line. Just look at the recent shoot-the-lights-out IPO of Sezzle Inc. (ASX: SZL).

Xero also has the advantage of knockout subscriber growth (31% from the most recent numbers) and revenue growth (32%).

All of these factors have combined to drive investors crazy over Xero stock, despite its so-far lack of profitability and its revenue of $63.8 million of revenue resting on a market capitalisation of $8.47 billion.

Foolish Takeaway – Is Xero a buy?

This lofty valuation is assuming Xero’s impressive growth numbers will continue for many years – which is fine, Xero is showing all the signs of being a future ASX heavyweight. But it also leaves today’s stock highly vulnerable to stock market corrections and/or crashes. Even today, the ASX 200 index was down 2.4%, but Xero took a 6% trimming. I would be concerned about what would happen to XRO shares if the ASX200 dropped 10% – I don’t think it would be pretty.

Bottom line (for me anyway) Xero’s share price remains a little risky, even after today’s falls.

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Motley Fool contributor Sebastian Bowen 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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