3 reasons I think Xero shares are a top buy right now

Xero is an appealing stock to me.

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Xero Ltd (ASX: XRO) shares are an appealing buy to me for a number of different reasons.

The ASX tech share has done very well for shareholders, as we can see on the chart below – it's up 125% in the past five years and has climbed 75% since the end of 2022.

I think there is plenty more growth to come due to three factors.

Growing subscriber base

A key driver of Xero's revenue and scale is how many subscribers it has.

Over the past decade, the business has become one of the world's largest cloud accounting software businesses.

Xero's subscriber base continues to grow at an impressive rate. In the six months to 30 September 2023, the company reported a 13% year-over-year increase in subscribers to 3.94 million, up from 3.5 million.

I don't know what subscriber numbers are going to do in the coming years, but the company has proven to have appealing tools for business owners and accountants to save time and do things more efficiently. More growth would be helpful for Xero shares.

Increasing average revenue per user (ARPU)

The amount the average user is paying is steadily rising, which is another boost to revenue.

Xero has just announced its latest plan/price changes in Australia, with there being another sizeable increase in prices.

The business saw ARPU increase 6% in HY24 to $37.28 and these other price rises may mean a material increase in ARPU.

Xero has historically had a very high retention rate, which could mean it won't lose many subscribers in the coming years.

Operating leverage

The ASX tech share has already developed its platform, so extra revenue is largely a boost for profitability. In HY24, revenue rose by $141 million and free cash flow grew by $91.1 million.

With a gross profit margin of over 87%, the company's new revenue largely turns into extra gross profit, which helps the earnings before interest, tax, depreciation and amortisation (EBITDA), net profit after tax (NPAT) and free cash flow.

Investors usually judge a large business based on how much profit it's making and how much it may make in the future. I think Xero's profit measures are going to soar in the next few years.

The more revenue that Xero generates, the more I expect its profit margins to improve in the long term.

Foolish takeaway

According to the forecast on Commsec, the Xero share price is valued at around 60x FY26's estimated earnings. That may be very reasonable if its profit can keep climbing in future years.

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. has positions in and has recommended Xero. The Motley Fool Australia has positions in and has recommended Xero. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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