3 reasons why I think the Xero share price is a top buy today

The Xero Limited (ASX: XRO) share price has seen plenty of pain since inflation and interest rates went crazy. It’s still down more than 40% compared to its November 2021 price.

However, in the last 12 months, Xero shares are only down by 9%. The company’s share price has been rising in recent weeks as the business revealed its plans to become more profitable. That’s one of the main reasons why I think Xero shares can do better than the market this year, next year, and beyond.

Rising profit margins

One of the big things that many investors are typically hoping for is profit growth from their investments.

Xero has made very little profit since it listed on the ASX. For a long time, the ASX tech share hasn’t been bothered about trying to make a profit. It has focused on long-term growth and global expansion. And that has been a worthwhile activity.

But, while Xero has been achieving a strong gross profit margin for some time, it also wants to improve its operating profit margins as well.

Earlier in March, the company announced a plan to reduce costs and drive “disciplined growth”. This will involve reducing its job count by between 700 to 800 roles.

In FY23, it’s expecting its operating expenses as a percentage of operating revenue to be “towards the lower end of a range” between 80% to 85%. That excludes restructuring charges associated with the program of between $25 million to $35 million.

Management is targeting an operating expense-to-revenue ratio in FY24 of around 75%. With that in mind, FY24 could show a big improvement in profit.

I think that a demonstration of improving profitability will encourage investors and send the Xero share price even higher.

Strong revenue growth

I also think one of the biggest drivers of the Xero share price will be its ability to keep growing revenue.

Increasing scale can have such a positive effect on a business with a gross profit margin of around 87%.

In the FY23 first half, it saw operating revenue increase by 30% to $658.5 million. This was partly driven by a 16% increase in total subscribers to 3.5 million, while average revenue per user (ARPU) grew by 13% to $35.30.

It helps that the business has been able to increase subscription prices. In November 2022, it reported that its annualised monthly recurring revenue (AMRR) had grown 31% year over year to $1.48 billion. This suggests that some revenue growth is already locked in for the next result.

The global economy is a big place for the ASX tech share to expand into. Indeed, there are still many more businesses in Australia, the UK, South Africa, and so on that could go digital.

High levels of customer loyalty

However, I don’t think there’s much point in winning lots of subscribers if the business loses them quickly afterwards — that’s essentially a waste of marketing resources.

But, if a business has a high retention rate, then that bodes well. If a company had a retention rate of 80%, meaning it loses 20% of its customers in a year, it would need to replace the equivalent of its whole customer base after five years. A retention rate of 90% would mean losing 10% of its customer base, so it’d have to replace its customer base every 10 years.

In the FY23 half-year result, Xero said its retention rate was over 99%.

This high level of customer loyalty means Xero’s customers seem to love its software, and that Xero can implement profit-boosting price increases with little negative effect.

Xero share price snapshot

Since the start of the year, the Xero share price has risen by 28% and I think it can comfortably beat the market from here to the end of 2024 because of all the factors above.

The post 3 reasons why I think the Xero share price is a top buy today appeared first on The Motley Fool Australia.

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• 3 ASX All Ords tech shares rebounding strongly from the SVB fallout (and 2 still tumbling)
• If I’d invested $5,000 in Xero shares a week ago, here’s how much I’d have now!
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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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