Constellation Software (TSX:CSU) stock is one of the best performing stocks on the TSX over the past 10 and 15 years. If you bought this stock in 2013 and held it to today, you would be sitting on a 1,656% total return! If you had owned it since 2008 (just a few years after its initial public offering (IPO)), you’d have a 10,195% total return.
Constellation Software is a Canadian 100-bagger stock
That is a 100-bagger. It might be one of the quickest 100-baggers in Canadian history with a 36% compounded annual rate of total return. For context, a $10,000 investment in 2008 would be worth $1,029,917!
What does Constellation do?
Before we ask if Constellation is a buy, we should ask how it got here?
Constellation operates and acquires vertical market software (VMS) businesses around the globe. VMS generally provides specialized, niche software for specific purposes, industries, or markets.
There are plenty of these businesses around the world. Despite having a market cap of $56 billion, it still acquires VMS businesses worth as little as $5 million.
In fact, Constellation has a database of tens of thousands of potential acquisition candidates. Currently, it has over 600 businesses under its fold, but it has a huge market to still consolidate.
Plenty of opportunities to keep growing
Constellation Software is a decentralized organization. This means that it delegates responsibility for operations and acquisitions down to smaller business units. As a result, it is able to acquire a significant number of small businesses efficiently without costs exploding.
VMS tends to be essential to its customers. Generally, the software is difficult to replicate or replace. As a result, Constellation is very recession-resistant. Given its asset-light model, its businesses generate a significant amount of free cash flow.
Since 2018, it has nearly doubled free cash flow available to shareholders (FCFA2S) to $984 million over the past 12 months. This is basically the excess cash it generates that it has to re-invest into more businesses. The more businesses it has, the more cash it generates, the more businesses it can buy. That is how Constellation compounds value.
Is Constellation cheap or pricey?
This can make Constellation hard to value. On a price-to-earnings basis, it trades for 84 times. That seems extremely expensive. However, given the high level of amortization expense due to its various software assets, net earnings are not always the best measure of real cash flows and profitability.
On a price-to-free cash flow basis, it trades for 20.7 times. While that still is quite high, it is below its five-year average of 22.5. On an enterprise value-to-earnings before interest, tax, depreciation, and amortization (EV/EBITDA) basis it trades for 20. That is slightly above its five-year average of 19.9.
Undoubtably, Constellation Software is not cheap. However, if it can maintain its 20%-plus annual growth rate that it has averaged over a decade, the stock does not look overtly pricey. If it continues to generate more cash and re-invest at elevated rates of return, the stock is probably fairly valued, to a slight bargain.
Is Constellation Software stock a buy?
When you buy Constellation Software stock, you are buying one of the greatest compounding platforms in the world. The company has some of the best capital allocators in the world.
While it is already a large company, it has been spinning-out companies as a way to unlock further shareholder value. This is likely to continue in the future. If you factor spin-outs into the equation, this stock could be a real bargain today, especially if you look out over the next 5 and 10 years.
