Many investors may be wondering if the dizzying run-up in the valuations we’re seeing in the technology sector are sustainable. For one Canadian software giant, these sorts of returns haven’t occurred only in recent years. In fact, this company has provided this kind of growth for more than a decade!
Constellation Software (TSX:CSU) is a growth company with the fundamentals and catalysts that provide a solid case for this kind of growth to continue.
What does Constellation do?
Constellation Software is essentially a consolidator of software companies. Similar to other growth-by-acquisitions plays, Constellation picks up great small-cap companies at good prices and increases their earnings potential over time. The company does this via synergies, cost improvements, and scale.
This is an extremely well-run company, with a management team that is world class. Since this company is traded in Canada, I think Constellation has largely been under the radar for some time. Constellation’s management team is one of the best in terms of implementing an acquisition-oriented growth strategy I’ve seen. There are currently thousands of companies that fit Constellation’s investment profile, so the runway for growth for this stock is really unlimited right now.
Accordingly, for those looking for long-term, sustainable growth, this is a stock I’d recommend considering now.
Let’s take a look at another key factor supporting just how successful Constellation has been with its growth strategy. Indeed, cash flow metrics ought to be key for any investor.
Constellation is a free cash flow machine
Looking at free cash flow is important, because this is what the company has left over after paying all its expenses and settling its books each and every quarter. This is more of a pure metric than earnings, because this takes a lot of corporate costs into consideration. Further, this is the capital the company has at its disposal to reinvest, hike its dividend, and allow the company’s management team to create value for shareholders.
The company’s free cash flow return on invested capital is 59%. This is absolutely incredible. This means that for every dollar that the company takes in (via equity markets or debt), it earns $0.59 in free cash flow.
Additionally, the company’s free cash flow margin is an impressive 23%. This means that Constellation’s bottom line grows by $0.23 for every dollar that comes in via revenue. If you’re bullish on revenue growth with this company over time, which is easy to do given Constellation’s track record of well-timed and well-priced acquisitions, this will indeed be a very profitable company over time.
Free cash flow has increased at around 30% a year in recent decades, a factor which has driven this stock toward all-time highs. For those worried about the valuation with this company, consider a free cash flow growth rate of only 10-20% and plug that into your model. Thus, I think it’s clear this company is cheap on the basis of growth right now, despite its enormous stock price appreciation of late.
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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 Chris MacDonald has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Constellation Software.