Xero Limited (ASX: XRO) shares have surged more than 30% since hitting a low in early April.

This has caught many investors by surprise, particularly because when the Xero share price decreased by 24% from February to April this year, few were expecting a V-shaped recovery just two months later.

So with the stock near all-time highs, the natural questions are: Have you missed the boat? Can Xero shares keep rising?

In my view, Xero shares can keep rising from here, and I think there is still upside potential from the current share price. Here's why.

Strong fundamentals

Let's start with the fundamentals. Xero is a business with a strong competitive advantage, management is executing well, and there is good reason to believe that will continue in the foreseeable future.

In FY25, Xero generated $2.1 billion in revenue, up 20% from the prior year on a constant currency basis. The company added 414,000 subscribers, bringing its subscriber base to 4.41 million.

Average revenue per user (ARPU) rose 15% to $45, whilst churn held steady at a low 1.03%, and free cash flow surged 48% to $507 million, comfortably ahead of expectations.

At $45, I think the ARPU can continue to increase, given that this is a mission-critical product loved by the accountants who serve most of Xero's small and medium-sized businesses.

Management guided to a 71.5% opex-to-revenue ratio for FY26, which was higher than expected. However, that includes non-recurring executive costs. Stripping those out implies the true cost ratio is closer to 69.5%, roughly in line with prior expectations.

With Xero shares currently trading at $184.29, many brokers (including Morgan Stanley, JP Morgan, BofA, and RBC) remain bullish on the company, with price targets between $190 and $225.

Xero-ing in on the Rule of 40

A major reason I'm still bullish is that Xero continues to deliver on the Rule of 40, a popular benchmark that combines revenue growth and free cash flow margin to evaluate a SaaS company's execution (with 40 being the target).

In FY25, Xero posted 20% revenue growth (constant currency) and a 24% FCF margin, giving it a Rule of 40 score of 44%. It's outstanding for a large company to demonstrate that level of growth, expand into new markets, invest in products, and still generate meaningful cash flow.

A key takeaway here is that Xero has demonstrated that it can be wildly profitable while still growing at a fast clip. I think it's possible that management leans harder into growth (possibly at the short-term cost of profitability) so as to scale the business further and meaningfully uplift future profitability.

Can Xero reconcile its steep valuation?

There is no hiding from it – Xero shares aren't cheap. They trade at over 80x forward earnings, and while one could argue that premium companies demand premium valuations, this leaves no room for error and requires flawless execution.

On valuation grounds alone, anything can happen to Xero shares in the short term, irrespective of how well management executes. That is certainly a risk to be mindful of.

Overall, I remain bullish on Xero shares. With the benefit of hindsight, the April dip was a gift, but you won't always get the perfect entry point. If you are a long-term investor who believes in durable SaaS companies with sticky customer relationships, I think you ought to take a close look at Xero. The price might be steep, but the business still adds up.