The Xero Limited (ASX: XRO) share price has doubled over the past year, but I think there are plenty of reasons why investors should stick with Xero:
Stay with winners
There are few businesses that come along that are as high-quality as Xero. The entire share market is trading at a higher valuation. Some businesses are trading at cheaper prices because they have poorer growth prospects or they’re facing specific issues. They may not be good value just because they’re cheaper.
It’s probably better to pay today’s price for Xero than go for a decently-priced bad business.
Plus, if you’re already a shareholder of Xero and you sell you’d be causing a capital gains event which means tax could take away from some of your returns. Taxes can be a major negative to long-term returns.
Many of the businesses on the ASX that have created the best returns are ones that are growing internationally. Places like the US, the UK and so on are much larger markets and opportunities for Xero compared to Australia.
In the result in the first half of FY20, Xero revenue increased by 32% and total subscribers increased by 30%. Australian subscribers grew by 28% to 840,000, UK subscribers grew by 51% to 536,000, New Zealand subscribers increased by 13% to 367,000, North American subscribers grew by 21% to 215,000 and ‘rest of the world’ subscribers increased by 52% to 99,000.
Xero has some of the most attractive economics on the ASX. It now has a gross profit margin of 85.2%, up from 82.8% a year ago.
It’s this very high margin that helped earnings before interest, tax, depreciation and amortisation (EBITDA) before impairments to grow by 91% while revenue only grew by 32%.
Xero is making enormous strides every year. It has now reached profitability and positive free cash flow, but it still plans to heavily invest for more growth. If Xero has places that it can effectively spend money then it’s better for Xero to do that rather than make profit (and pay tax) for no particular reason.
Xero is very effective at identifying what its service is missing to win over more subscribers. For example, in the US it sought to solve the payroll issues relating to all the different rules for different US states. In the UK it worked on improving its compatibility and efficiency for clients to lodge tax returns with the UK tax office. Xero is definitely one to watch, particularly in this low interest environment.
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Motley Fool contributor Tristan Harrison 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.