Should the Xero share price have a P/E ratio of 4,000?

The Xero Limited (ASX: XRO) share price trades at a price to earnings (P/E) ratio of 4,122 – but is the ASX tech share overvalued?

| More on:
Price to Earnings (P/E) Ratio, ASX shares

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The Xero Limited (ASX: XRO) share price has been a top ASX tech performer for quite some time. Shares in the Aussie software provider are up 11.66% this year while the S&P/ASX 200 Index (ASX: XJO) has slumped 11.11% lower.

But there's one that thing that really stands out about Xero right now. The Aussie tech group's shares trade at a price to earnings (P/E) ratio of 4,122.29. That's a pretty astonishing number, but does it mean Xero is overvalued today?

Is the Xero share price overvalued?

Xero is currently trading at $89.33 per share. A P/E ratio of 4,122 means that for every $4,122 you pay for the share, you can expect the company to generate $1 worth of earnings.

That's an incredibly high number. Let's compare that figure that to a strong dividend share like Fortescue Metals Group Limited (ASX: FMG). Fortescue shares are currently valued at $14.66 with a P/E ratio of 6.04.

Of course, we have to compare apples with apples. This means it might be more appropriate to evaluate the Xero share price against that of its WAAAX peers. The Altium Limited (ASX: ALU) share price, for example, currently trades at a P/E ratio of 62.16. Therefore, on the surface it might appear that Xero shares are grossly overvalued.

However, I don't think it's that simple. The Xero share price has consistently climbed over the years and investors continue to buy into the company. The group continues to sign big clients and I think small and medium business clients will rely on Xero software throughout the COVID-19 crisis. 

Furthermore, many ASX tech shares don't actually post positive earnings or 'profit'. That means the earnings component of the P/E ratio is useless and won't provide any decisive value. However, if a company posts a 1 cent per share profit, all of a sudden their P/E ratio will be enormous.

Foolish takeaway

I don't think it's wise to just use P/E ratios to value the Xero share price, particularly in the current climate. If Xero retains key customers and manages to reduce churn, the ASX tech share could still be a good buy in 2020 and beyond.

Motley Fool contributor Ken Hall has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Altium and 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.

More on Technology Shares

Woman looks amazed and shocked as she looks at her laptop.
Share Gainers

If you'd put $20,000 in this ASX tech stock 20 months ago, you'd have $125,000 now

Having a massive winner like this can soothe the pain of losers in your portfolio.

Read more »

A man in his office leans back in his chair with his hands behind his head looking out his window at the city, sitting back and relaxed, confident in his ASX share investments for the long term.
Technology Shares

Why this leading broker just upgraded DroneShield shares

A buying opportunity has opened up for investors according to this broker.

Read more »

A woman weraing a stripy t-shirt winks as she points to the decorative gold crown on her head .
Technology Shares

Goldman Sachs has added this ASX 200 tech stock to its APAC conviction list

Here's why the broker is feeling very bullish about this market darling.

Read more »

a man in a business suite throws his arms open wide above his head and raises his face with his mouth open in celebration in front of a background of an illuminated board tracking stock market movements.
Technology Shares

Guess which ASX tech stock is jumping 15% today

Investors are cheering an update on a major project.

Read more »

A woman jumps for joy with a rocket drawn on the wall behind her.
Technology Shares

Why Life360 shares can keep rocketing

Goldman Sachs has become even more bullish on the market darling.

Read more »

a man smiles broadly as he holds up five fingers on one hand and two fingers on the other hand.
Technology Shares

How to invest in the magnificent seven stocks on the ASX

Want to invest in the magnificent seven? It's easy on the ASX.

Read more »

Three analysts look at tech options on a wall screen
Share Market News

Here's how the ASX 200 market sectors stacked up this week

ASX tech shares are on fire, leading the 11 market sectors for a third consecutive week.

Read more »

A man wearing a red jacket and mountain hiking clothes stands at the top of a mountain peak and looks out over countless mountain ranges.
Technology Shares

The Nasdaq just hit a fresh all-time high. What could it mean for Aussie investors?

With the Nasdaq at fresh highs, ASX tech shares are reaping the benefits.

Read more »