Cloud software provider Xero Limited (ASX: XRO) has grown phenomenally since it started in 2006.
The business started in a tiny apartment in Wellington, New Zealand, where the first employees had to pinch wifi from the neighbouring cafe.
And now, it has a market capitalisation of $20.72 billion.
It started its publicly listed life on the NZX, but even just during its ASX life, Xero shares have returned an eye-watering 2,896%.
So has all the money been made now? It wouldn’t be outrageous to suggest all the decent growth is now behind it?
That’s the question The Motley Fool’s chief investment officer Scott Phillips and analyst Chris Copley set out to answer in a recent video.
How Xero grew from zero to hero
Although commonplace now, the idea of cloud-based accounting was revolutionary in the mid-noughties when founder Rod Drury decided to make it reality.
According to Copley, formerly an accountant, the company was “an early mover” in the cloud accounting industry.
“I used to train different clients on how to use some of these accounting platforms, and Xero was by far my favourite solution,” he said.
“We could teach them how to do the bookkeeping on Xero because it was so easy to do and that saved them costs.”
This ease of use, and the network effects of accountants actually recommending the software to their clients, propelled the incredible growth of Xero over the past decade.
Phillips said that the company’s origin and growth narrative was irresistible.
“It’s one of Australasia’s great success stories of the last 20 years.”
Plenty of reasons to continue growth
But investors must look forward, not backwards.
Xero shares ended Friday at $139.30, which is a 9% drop over the month. Is the market starting to lose faith in the sustainability of its growth?
Copley said the global addressable market for cloud accounting is massive, and that Xero has only “scraped the surface” so far.
“Cloud adoption globally is really low relative to Australia and New Zealand.”
He added that the business is still running in ‘capture market share’ mode, so it has room to improve its margins in the future.
Xero is also developing into a small business suite, through collaborative partnerships with non-accounting software. This makes the platform more “mission critical” for its customers, according to Copley, and more “difficult to leave”.
But there are risks for Xero shares
Having a small business clientele means Xero is exposed to the whims of the economy, according to Copley.
And the company doesn’t have the head-start in the expansion markets as it did in Australia and New Zealand 10 years ago.
“There are solutions in the US like QuickBooks Online, which is Intuit Inc (NASDAQ: INTU)’s cloud-based accounting software,” Copley said.
“It has quite a comparable solution to Xero but has a larger market share in the US, and the business is growing at a similar rate.”
Also, regardless of geography, Xero’s rivals have now woken up to the fact that cloud is the future. The likes of old desktop rivals MYOB and Reckon Limited (ASX: RKN) are fast developing competitive solutions.
“Xero will need to continue to innovate and continue to innovate its solutions.”
Are Xero shares worth it now?
Copley said that with the valuation so high now, one could not buy Xero shares now with the expectation that it would rise 729% like the last 5 years.
“There’s a lot of lofty expectations built into the share price that investors should be wary of when investing in Xero.”
But having said that, Copley still made the call that Xero shares are a “market beater”.
“It’ll continue to grow. It’ll continue to grow for a long period of time. Its tail is long, which means I think it can get double-digit growth for a long period of time,” he said.
“You really do need to look well long term into the future for this one because even in 3 to 5 years it’s still going to probably have quite a lofty multiple.”