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3 reasons why Xero (ASX:XRO) shares could be a buy

xero share price
Source: Xero

The Xero Limited (ASX: XRO) share price has been volatile in recent times. There are some reasons why investors may want to research Xero.

What’s Xero?

Xero describes itself is one of the fastest growing software as a service (SaaS) companies globally. It boasts that it leads the New Zealand, Australian, and United Kingdom cloud accounting markets, employing a quality team of more than 3,000 people. Forbes identified Xero as the world’s most innovative growth company in 2014 and 2015.

It operates cloud-based accounting software to connect people with the right numbers anytime, anywhere, on any device. For accountants and bookkeepers, Xero helps build a trusted relationship with small business clients through online collaboration.

Reasons why Xero shares may be a compelling idea

The Xero share price has fallen by 13% since 5 January 2021. These are some reasons that investors may like Xero:

Reason 1: High gross profit margin

Xero is an ASX technology share with one of the highest gross profit margins in Australia or New Zealand.

In the FY21 half-year result Xero reported that its gross profit margin percentage improved from 85.2% to 85.7%.

Whilst the gross profit margin is not the bottom line net profit, it is a contributing factor to boosting that profit. The high gross profit margin is one of the main reasons why the 21% increase in operating revenue to NZ$410 million led to a NZ$56 million increase in earnings before interest, tax, depreciation and amortisation (EBITDA), a NZ$33 million rise in net profit after tax and a NZ$49.5 million jump in free cash flow.

The ASX share may be able to achieve more operating leverage as it continues to scale with more global subscribers.  

Reason 2: Global subscriber growth

Xero’s revenue comes from its subscribers in the form of monthly subscription payments. In the FY21 half-year period it saw global subscribers grow by another 19% to 2.45 million. This drove annualised monthly recurring revenue higher by 15% to NZ$877.5 million and the total lifetime value of subscribers went up 15% to $6.17 billion.

Some of the strongest performing ASX shares over the last decade have been businesses exposed to international growth. Look at large caps like CSL Limited (ASX: CSL), Macquarie Group Ltd (ASX: MQG), Goodman Group (ASX: GMG) and Aristocrat Leisure Limited (ASX: ALL).

In the FY21 half-year result, Xero revealed that its Australian and New Zealand subscribers grew by 21% and 13%.

Management were pleased that UK subscribers went higher by 19% to 638,000. North American subscribers went up 17% to 251,000. Rest of the world subscribers rose by 37% to 136,000 with growth being led by South Africa and further growth was made in Singapore.

Reason 3: Platform effects

Businesses that boast of platform effects can create a very strong ecosystem. For example, accountants that love Xero may want their clients to shift to using Xero. Clients that love Xero will want to stick around – Xero does have a high retention rate.

The cloud accounting software business also offers various add-ons and access for third party developers to create their own modules to work and add further functions for users.

Xero recently acquired Hubdoc. Hubdoc is a data capture tool which extracts key data from documents, then creates transactions in Xero. It has also made an alliance with US payroll provider Gusto and it has acquired invoice lending platform Waddle.

Where to invest $1,000 right now

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*Returns as of February 15th 2021

Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of CSL Ltd. and Xero. The Motley Fool Australia owns shares of and has recommended Macquarie Group Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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