However, I think Xero still has excellent long-term prospects as the world turns ever more digital. There are three reasons I’m betting big on Xero today:
1. Xero is a ‘first mover’ in an important, emerging industry
Being a first mover in an important, emerging industry is one of Motley Fool co-founder David Gardner’s six traits of a ‘rule breaker’ investment. Successful first movers have a head start in building a competitive advantage which is essential to long-term success.
Xero was a pioneer of cloud-based accounting software, thanks to founder Rod Drury, and has taken that lead and run with it. The company now dominates in Australia and New Zealand with more than 1.3 million subscribers. I believe Xero’s early learnings about how to adapt and scale to new geographies are strong foundations for its continued growth into new countries.
2. Xero has a strong switching cost moat
A switching cost moat is a competitive advantage that makes it hard for customers to change to a competing product. One way Xero does this is by winning over accountants – the people who look after our tax. If my accountant tells me to subscribe to Xero, because that’s how she manages my tax, then that’s what I’ll use.
In addition, Xero’s software becomes a core part of the daily operations of the businesses it serves. It can be a daunting and time consuming task to shift to a competitor. This creates strong customer retention giving Xero valuable pricing power.
3. I think Xero has a significant growth runway
If 2020 has taught us anything, it’s that software is eating the world more quickly than ever. Yet it feels like accounting and tax industries have been slow to the dinner table. This will change as countries like the United Kingdom increasingly push to ‘make tax digital’ and I think Xero will be perfectly placed to keep growing.
I do expect subscriber growth to slow in the next 12 months as small companies battle the scourge that is COVID-19. However, I think the Xero share price will continue to compound growth masterfully over the next decade.
My thesis for owning Xero shares centres around it being an early mover with a strong economic moat in an important, emerging industry. The company may hit some speed bumps over the next 12 months, but I think it has excellent long-term prospects.
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Regan Pearson owns shares of Xero.
You can follow him on Twitter @Regan_Invests.
The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of Xero. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.