One Thing To Consider Before Buying Xero Limited (ASX:XRO)

If you are looking to invest in Xero Limited’s (ASX:XRO), or currently own the stock, then you need to understand its beta in order to understand how it can affect the risk of your portfolio. There are two types of risks that affect the market value of a listed company such as XRO. The first risk to think about is company-specific, which can be diversified away by investing in other companies in order to lower your exposure to one particular stock. The second risk is market-wide, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks.

Different characteristics of a stock expose it to various levels of market risk. A popular measure of market risk for a stock is its beta, and the market as a whole represents a beta value of one. A stock with a beta greater than one is expected to exhibit higher volatility resulting from market-wide shocks compared to one with a beta below one.

View our latest analysis for Xero

An interpretation of XRO’s beta

Xero’s five-year beta of 1.81 means that the company’s value will swing up by more than the market during prosperous times, but also drop down by more in times of downturns. This level of volatility indicates bigger risk for investors who passively invest in the stock market index. Based on this beta value, XRO may be a stock for investors with a portfolio mainly made up of low-beta stocks. This is because during times of bullish sentiment, you can reap more of the upside with high-beta stocks compared to muted movements of low-beta holdings.

ASX:XRO Income Statement Mar 31st 18
ASX:XRO Income Statement Mar 31st 18

Does XRO’s size and industry impact the expected beta?

With a market capitalisation of AU$4.59B, XRO is considered an established entity, which has generally experienced less relative risk in comparison to smaller sized companies. However, XRO operates in the software industry, which has commonly demonstrated strong reactions to market-wide shocks. Therefore, investors can expect a low beta associated with the size of XRO, but a higher beta given the nature of the industry it operates in. It seems as though there is an inconsistency in risks from XRO’s size and industry. A potential driver of this variance can be a fundamental factor, which we will take a look at next.

Is XRO’s cost structure indicative of a high beta?

During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta. I test XRO’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Given that fixed assets make up less than a third of the company’s total assets, XRO doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns. Thus, we can expect XRO to be more stable in the face of market movements, relative to its peers of similar size but with a higher portion of fixed assets on their books. However, this is the opposite to what XRO’s actual beta value suggests, which is higher stock volatility relative to the market.

What this means for you:

You could benefit from higher returns during times of economic growth by holding onto XRO. Its low fixed cost also means that, in terms of operating leverage, it is relatively flexible during times of economic downturns. What I have not mentioned in my article here are important company-specific fundamentals such as Xero’s financial health and performance track record. I highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for XRO’s future growth? Take a look at our free research report of analyst consensus for XRO’s outlook.
  2. Past Track Record: Has XRO been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of XRO’s historicals for more clarity.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.