The year 2022 has been immensely tumultuous for investors. From tech stocks to gold and from defensives to cryptocurrencies, everything has been on a tear on recession fears. Tech stocks have been among the laggards and have lost about 40% so far this year. However, one TSX tech stock that has fared relatively better is Constellation Software (TSX:CSU).
CSU stock notably outperforms
CSU has dropped merely 10% this year, better than peers and broader markets. Rising rates and unwavering inflation generally pull down high-growth stocks, mainly those that are richly valued. However, CSU stock is still trading strong at 75 times its earnings and has outperformed. So, what is it that has kept its vigour intact in such hot-blooded markets? And will it continue to outperform?
Constellation Software is a $40 billion tech company that acquires and manages a fleet of smaller vertical market software companies. These companies provide mission-critical software that addresses the particular needs of specific customers. Constellation management eyes smaller software firms with tremendous growth potential and a leadership position in a particular area. Constellation develops them and caters to the wider customer base with this fleet. This has allowed it significant cash flow generation over the past several years.
In the past 10 years, the company has managed to grow its earnings by 21% CAGR, which is notably higher than average. Thus, CSU stock has returned 36% CAGR in the same period. So, if you invested $10,000 in CSU stock in 2012, you would have accumulated $230,000 today.
What’s so special about Constellation Software?
Constellation has a strong balance sheet that plays well for its inorganic growth aspirations. Apart from financials, management’s knack for picking out high-potential companies has been a key driver for its consistent strong growth.
Last year, Canada’s second-largest tech company conveyed its plans to take up more aggressive acquisitions and bigger deals. As a result, it has been quite active this year and has completed 30 acquisitions only in Q2 2022, according to RBC Capital Markets, reported by BNN Bloomberg. It has invested $1.2 billion so far this year — a record pace of deals for Constellation.
Interestingly, this year’s market weakness could have played in favour of Constellation, giving it an edge with its financial capabilities against smaller companies. Given the expanding fleet and scale, the company will likely see superior financial growth in the next few years.
Valuation
Constellation stock has almost always traded at a premium valuation. As stated earlier, it is trading 75 times its earnings, way higher than its peers. However, its five-year average P/E comes in at around 69 times. Considering its consistent profitability and unique business model, CSU stock’s premium valuation looks justified. And importantly, its strength in such volatile markets indicates investors’ confidence and strong growth prospects.
