This Growth Stock Could Provide 20% Annual Returns for 100 Years

Constellation Software Inc (TSX:CSU) has provided incredible returns to shareholders and could provide returns greater than 20% for a long time.

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Constellation Software (TSX:CSU) acquires, manages, and builds vertical market software (VMS) businesses. VMS businesses provide critical software solutions that address specific customer needs in particular vertical markets. The company focuses on acquiring businesses with growth potential and then builds them to generate significant cash flow and revenue growth. The company uses a combination of proprietary software and market expertise to provide software solutions designed to enable customers to boost productivity, operate more cost effectively, increase sales, and improve customer service and satisfaction.

Constellation targets the VMS sector because of the attractive economics that it provides and Constellation’s management teams expertise of the economics of VMS businesses. The company seeks acquisitions that provide software solutions to either the public or private sectors. The company often enters new vertical markets through acquisitions of VMS businesses and expands existing businesses through organic growth initiatives aimed at increasing market share and product breadth.

Constellation seeks to acquire attractive VMS businesses in new markets to deploy free cash flow at attractive returns. Constellation usually retains the majority of the managers from the businesses acquired, which allows the company to retain the knowledge needed to manage and successfully build the businesses. The acquired VMS businesses typically generate significant cash flows, which the company redeploys to build existing VMS businesses and acquire new ones.

Constellation looks to acquire growing VMS businesses with a diversified customer base, high relative market share, and capital-constrained competitors. The company maintains a decentralized management structure and has experienced management teams operating in each VMS business, backed by infrastructure at the operating group level and a small corporate head office. The company’s corporate head office provides financial and strategic expertise with respect to capital allocation, acquisitions, finance, tax, and compensation policy, and identifies and shares best practices.

The company has six operating groups to service customers in more than 100 different vertical markets worldwide. The company monitors and measures each VMS business unit’s performance through operating ratios and metrics, including profitability and growth, as measured by return on invested capital and net revenue growth. The company ensures that a majority of senior managers’ incentive compensation is linked to these two performance metrics.

Constellation’s decentralized management structure allows it to have business unit management teams with strong customer relationships and deep market knowledge that are more focused and responsive than would be the case under a centralized management model. These teams provide the company’s corporate head office and operating group managers with the ability to focus on issues such as capital allocation, identifying best practices, and helping recruit and coach high-potential employees.

The company requires that at least 25% of the incentive compensation for employees who earn in excess of $75,000 per annum be reinvested in Constellation shares that are subject to restrictions on resale for a period of five years. Senior executives are required to invest 75% of their bonus in Constellation shares.

This gem of a company has provided incredible returns to shareholders and could provide returns greater than 20% for a long time.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nikhil Kumar has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Constellation Software.

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