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Key points
- The Motley Fool Australia analyst Ryan Newman picked Xero shares as a buy
- He told our chief investment officer Scott Phillips about the company's numerous strengths
- However, Xero shares come with 3 key risks
The Xero Limited (ASX: XRO) share price has tumbled into the new year – it has fallen a whopping 22% since the final close of 2021 – but this Foolish expert is still betting on the stock.
The Motley Fool Australia analyst Ryan Newman discussed the company, its strengths, and its weaknesses with our chief investment officer, Scott Phillips earlier this week.
The conversation was part of The Motley Fool Australia's Stock of the Week series, which can be found on our YouTube channel. As always, readers can find coverage of the week's stock pick here and in podcast form here.
At the time of writing, the Xero share price is $110.36.
Here's why Newman believes the software-as-a-service (SAAS) company's future is bright.
Does Xero's 'sales force' make its shares a buy?
For many ASX market watchers, Xero shares were the gateway to cloud-based software. The company listed back in 2012 when much of the market knew clouds as fluffy and white in the sky.
Xero provides a cloud-based accounting platform. One of its major strengths is its 'sales force' of accountants and bookkeepers.
"[A] really important benefit that Xero brings is obviously between managers of a business – small businesses in particular – those small businesses really want to keep a strong relationship with their bookkeeper or with their accountant," said Newman. He continued:
Xero actually allows that to happen.
It's my understanding that most accountants really really love the Xero interface and the Xero product. Many more than what competitors offer … I absolutely think that having that sales force through the accountants and bookkeepers has been a major driver.
Accountants act as an extension of Xero's marketing arm which saves Xero the marketing dollars.
Additionally, the nature of Xero's cloud-based product is one of its strengths. Newman noted it allows Xero to sell its software as a reoccurring subscription, creating lower costs for customers and greater revenue for the company.
Looking to the future, Xero hopes to become a small business portal, says Newman.
What [Xero] want to try and do is help small and medium-sized businesses to perform mission critical tasks like payroll invoicing, expense tracking, bank reconciliation and, I suppose, ultimately to allow them to spend more time in managing their business rather than handling the financials.
That, over time, I believe will allow it to grow its average revenue per user.
Additionally, Newman believes the company can apply price increases without issue using a technique called 'land and expand'. He said:
Generally, these sorts of businesses are able to push through those pricing increases because, as I said, it's a mission critical service. Without Xero, what are the businesses going to do?
Most, if not just about every business that uses Xero, I think, will probably just be happy enough to pass over those extra couple of dollars per month, which over time can actually add up to quite a large value add for Xero.
What are the down sides to Xero?
Like any investment, Xero shares come with their own set of risks, of which Newman outlined 3.
Firstly, the company's expansion into the United States has so far been unsuccessful.
"It was always going to be a tough market to crack but ultimately, I would say that that market is essentially lost," said Newman. "One of the risks here is that Xero continues to really press and try to eke out as much as they can from it. I think that would be a mistake."
Innovation is another issue for Xero, as well as most other tech shares. Pushing development to stay ahead of competition takes money and comes with no guarantee of success.
Finally, involuntary customer churn is a risk factor for Xero.
Newman said, "the fact that Xero focuses predominantly on small and medium-sized businesses, some of these businesses are actually more prone to suffering through an economic recession, for instance."
