3 reasons why Xero (ASX:XRO) is a quality ASX share

Xero is a really good business with a number of factors that are helping its performance.

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Xero Limited (ASX: XRO) has a number of attractive features going for it, making it a quality ASX share.

What does Xero do?

The company is a technology business that aims to provide “beautiful” cloud-based accounting software that connects people with the right numbers anytime, anywhere, on any device.

Xero says that for accountants and bookkeepers, Xero helps build a trusted relationship with small businesses through online collaboration.

It aims to provide really effective tools and information to help business owners and accountants do what they want to, quicker, and get more valuable insights into the business.

But these are a few reasons why the business could continue to do well:

Very high profit margins

Xero has a very high gross profit margin percentage. In FY21 that margin had increased to 86%, up from 85.2%.

When the gross profit margin is that high, it means a large majority of new revenue can fall straight to the next profit line of the accounts.

At the moment, Xero is heavily investing for growth, so that high gross profit margin isn’t translating into significant profit (for its size).

But FY21 still showed a lot of scalability. Whilst operating revenue grew 18% to $848.8 million, free cashflow went up 110% to $56.9 million.

The half-year result particularly showed how much profit can increase when Xero isn’t spending so much on growth. HY21 operating revenue went up $71.2 million and free cashflow increased $49.4 million – that suggests a very good margin. Earnings before interest, tax, depreciation and amortisation (EBITDA) also saw significant growth. 

Even stronger ecosystem

Xero has a very strong platform for subscribers. Not only does it have an excellent core product for users, but it allows subscribers to link up with external software providers to improve what subscribers can do with their Xero numbers and their business.

The business has been busy making acquisitions to improve its global offering for subscribers. Three of the latest deals have been Planday, Tickstar and Waddle.

It offers much more than a bookkeeping system. Xero has the tools and connections that no other accounting software provider has. That can improve subscriber loyalty and decrease churn.

Xero said in the FY21 result that growing awareness among small businesses of the benefit of digital tools and cloud technologies contributed to lower churn and a 38% increase in total lifetime value to $7.65 billion.

Focus on investing growth is leading to results

Xero itself says that it will continue to focus on growing its global small business platform and maintain a preference for reinvesting cash generated, subject to investment criteria and market conditions, to drive long-term shareholder value.

This heavy focus on growth is helping the business increase in size quickly. In FY21, its total subscribers increased by 20% to 2.74 million. Within that, there was a 22% increase in Australian subscribers to 1.1 million, a 17% rise in UK subscribers to 720,000 and 40% growth of ‘rest of the world’ subscribers to 175,000.

Xero CEO Steve Vamos said:

The past year has brought home to many people in small business the need to understand in real-time their financial position and how it may change. The value and importance our customers place on their subscription and connection to the broader Xero community is increasing.

Looking ahead we believe small business will be a major driver of economic recovery in a post-pandemic world. Small businesses make up more than 90% of businesses in the markets Xero operated in, and represents a significant contribution to economic activity, jobs and the community.

Should you invest $1,000 in Xero right now?

Before you consider Xero, you'll want to hear this.

Motley Fool Investing expert Scott Phillips just revealed what he believes are the 5 best stocks for investors to buy right now... and Xero wasn't one of them.

The online investing service he’s run for over a decade, Motley Fool Share Advisor, has provided thousands of paying members with stock picks that have doubled, tripled or even more.* And right now, Scott thinks there are 5 stocks that are better buys.

*Returns as of January 13th 2022

Motley Fool contributor 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 and has recommended Xero. The Motley Fool Australia owns shares of and has recommended Xero. 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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