The Motley Fool

Should you buy Xero shares on this dip?

The Xero Limited (ASX: XRO) share price seems to be in a rare dip. Xero shares hit a new all-time high of $68.88 jut two weeks ago, but Xero today opened for $61.78 – a full 10% discount from the new high watermark.

So is this a buying opportunity for a company that seems to be always reaching new highs? Let’s take a look at Xero

Who is Xero?

Xero is the X in WAAAX – the ASX’s most high-profile club of tech darlings. The company was founded in 2006 across the ditch in New Zealand and only moved over to the ASX in 2012 (better late than never).

Xero’s purpose is to simplify accounting and taxational matters through the company’s namesake software, which is offered on a Netflix-style software-as-a service (SaaS) subscription basis. This business model is key to understanding the excitement surrounding Xero as it opened the company to receiving a growing pile of ‘recurring revenue’, which is a lucrative game, especially considering the stickiness that Xero’s software seems to possess.

Are Xero shares still expensive?

The short answer is yes (in my opinion, anyway). Even after the dip, Xero still has a market capitalisation of $8.86 billion. You would think a near-$9 billion company would have some strong profitability behind it, but Xero is still waiting to break even. What’s more, the company banked NZ$552.8 million (A$511.67 million) in operating revenue for the 2019 financial year – a princely sum to be sure, but less so for a company of Xero’s size.

Of course, Xero has issued guidance that it is expecting a 36% revenue increase in FY20, so it’s clear the market is valuing Xero on future, not present cash flows. But this is a risky game as no one knows what the future may hold. So the long answer is… maybe.

Foolish takeaway

If I sound too pessimistic on Xero, I’m probably showing my value investing roots here. I do think Xero is a top-notch company with a reasonably clear growth runway, which justifies a premium share price. However, its still too expensive for me today and I’m hoping for a better buying opportunity down the road.

I'm far more interested in these five quality shares on sale!

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Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Xero. The Motley Fool Australia has no position in any of the stocks mentioned. 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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