Why Motley Fool analyst Chris Copley is so bullish on this ASX tech share

Is this small-cap tech share worth adding to your portfolio?

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Key points

  • Motley Fool analyst Chris Copley has flagged ASX tech share Xref as a stock he believes has a bright future 
  • The analyst flagged the company's global market opportunities, growing revenues, and reasonable valuation as reasons investors might want to look into the stock 
  • Let's take a deep dive into both the 'buy' argument for the company and the risks that come with investing in its shares 

ASX tech shares have been taking a battering this year. Luckily, there's nearly always a buy to find if investors know where to look.

And this ASX tech share still has plenty of potential, according to our in-house analyst Chris Copley.

Copley sat down with our chief investment officer Scott Phillips earlier this month to discuss his bullish view of software provider Xref Ltd (ASX: XF1).

Their chat was part of The Motley Fool's Stock of the Week series. This week's stock pick, as well as past picks, can be found on our YouTube channel. Audio-lovers can also find this week's stock pick in podcast form here.

At the time of writing, the Xref share price is 64 cents.

Though, it's important for readers to keep in mind that when Copley talked over the company's investment thesis, its shares were trading at around 53 cents.

Let's break down why the analyst is optimistic about the tech company's investment potential.

But first, what is Xref?

It's a relatively unheard of ASX small-cap, but Xref is doing big things in the human resources (HR) sphere.

The technology company provides a cloud-based automated reference checking software for the employee hiring process.

It also has an ID verification leg – acquired in 2019 – and can provide employers with analytics, additional tools, and minimise fraud risks to help companies on their hiring journeys.

For instance, the company will flag with an employer if an applicant's references were sent from the same device as their application.

Xref has a market capitalisation of around $117 million and has been listed on the ASX since 2007, according to the exchange.

Why does this Motley Fool analyst see in the ASX tech share?

Chris Copley is bullish on ASX tech share Xref for plenty of reasons.

Firstly, he's been blown away by Xref's recent growth.

"In terms of execution, it has by far and away exceeded my expectations over the last couple of years," said Copley.

"In fact, Xref has been one of the very few companies which has managed to buck the growth company trend."

The Xref share price has gained an impressive 154% over the last 12 months.

For comparison, the S&P/ASX All Technology Index (ASX: XTX) has slipped 5% over the same time frame.

"The company generated sales growth of around 95% in the first half of the year," continued Copley.

"It also generated positive operating cash flow of around $2.3 million, so its top line growth has been very strong and this has been supported by the great resignation around Australia and around the globe over the last year and a half.

"But equally, even more impressive perhaps, is the fact that this growth, even if you look back over the last few years, has come without significant increases in its operating expenses."

The analyst also likes the niche space Xref is operating within. Though, it's still large enough.

The company's technology is available around the globe and in multiple languages. And Copley is impressed by the speed with which Xref has expanded internationally.

He noted that, in 2016, just 1% of its revenue came from overseas. Fast forwarding to Xref's most recent financial year, 7% of its sales came from Europe, 11% from North America, and 11% from New Zealand.

It also boasts a growing user base of "reputable" companies, says Copley, with plans to add more features to its offerings.

Additionally, since its 2019 acquisition of Rapid ID, the business' customer base has grown by more than 2,000%.

Copley also likes that Xref is still led by its founder and CEO, who is also its largest shareholder.

Finally, the analyst noted that, at the time of recording, the company was trading at a valuation of slightly more than 30 times its free cash flow.  That valuation "isn't particularly demanding," said Copley.

 What are some of the risks of investing in Xref?

While Copley is bullish on the ASX tech share, it's still important to outline some risks of investing in the company.

Firstly, Xref does have competitors. Copley noted it's worth keeping an eye on how those industry peers might slow or block Xref's expansion internationally.

Additionally, there's a risk that the company's clients could build their own automated reference checking solutions. That could be a "significant headwind on growth" for the ASX tech share, noted Copley.

There's also a "significant portion" of the company's target market that prefer to do reference checks 'the old-fashioned way'. That could limit the company's potential market, said the analyst.

Finally, because the company effectively charges users per use, its earnings are more susceptible to market cycles.

Recent record staff turnover has been helping it to grow lately.

But, as Copley noted, the job market will likely stabilise at some point. A more stable job market will probably see the company's growth scaling back to more 'normal' levels.

So, is the ASX tech share a buy?

All in all, Copley believes Xref shares are worth looking into.

"Right now, I think that Xref offers an attractive 'risk/reward' proposition for investors," he concluded.

The opinions expressed in this article were as at 16 March 2022 and may change over time.

Motley Fool contributor Brooke Cooper has no position in any of the stocks mentioned. Motley Fool analyst Christopher Copley owns Xref Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns and has recommended Xref Limited. The Motley Fool Australia has recommended Xref 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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