Everyone Is Talking About This Stock: Is It a Good Long-Term Option?

Constellation Software (TSX:CSU) stock is widely talked about. Does that mean it’s worth investing in?

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Some stocks have a lot of hype surrounding them. In general, a stock being talked about a lot is a red flag, as it may indicate that it’s overhyped. Every now and then, however, you’ll find a stock that is both hyped up and deserving of the hype. In this article, I will explore one Canadian tech stock that is both widely talked about and of high quality.

Constellation Software

Constellation Software (TSX:CSU) is a Canadian tech holding company that is a popular topic of discussion in financial communities like Twitter’s “Fintwit.” It’s hard to explain exactly what the company does operationally, because it does so many different things. Instead, we can look at CSU from the perspective of how it finances its growth and expansion.

Constellation Software operates much like a venture capital firm, meaning that it acquires small companies at an early stage in their growth. Unlike other such firms, though, it aims to integrate the companies it acquires into its own business, rather than acquiring small pieces of the companies on behalf of investors. The company aims to acquire smaller businesses for $5–10 million. It buys them when they are already generating revenue, rather than when they are at the idea stage. It’s an unusual business model, but it has worked out well for CSU, whose stock has risen 18,000% since it went public in 2006.

High growth

One of the reasons why CSU stock has risen so much is because the company underlying it has grown at a steady clip, too. In the most recent quarter, the company delivered:

  • $2.1 billion in revenue, up 23% year over year.
  • $177 million in net income, up 33%.
  • $513 million in cash from operations, up 60%.
  • $367 million in free cash flow, up 60%.

Overall, it was a strong showing. And the long-term performance has been good, too. In the most recent five-year period, CSU compounded its revenue, earnings, and free cash flow at the following rates:

  • Revenue: 22.2% CAGR.
  • Earnings: 13.8% CAGR.
  • Free cash flow: 28% CAGR.

Excellent growth.

Although there has been some concern about the fact that CSU gets most of its growth from M&A rather than organic growth, the company is not excessively leveraged. With a debt-to-equity ratio of almost exactly one, it has a pretty typical amount of leverage for a company of its type.

Decent profitability

Another thing that CSU has going for it is high margins. In the most recent quarter, the margins were:

  • Net margin: 8.3%.
  • Operating cash flow margin: 24.1%.
  • Free cash flow margin: 17%.

Pretty good margins all around. The situation was similar in the trailing 12-month period, which boasted the following numbers:

  • Net margin: 6.6%.
  • Operating cash flow margin: 21%.
  • Free cash flow margin: 27%.

The profitability picture is looking quite good for CSU. In both the most recent quarter and trailing 12-month period, the net margin was lower than the cash flow margins – that may indicate an increase in depreciation, asset impairments, or other write downs. That’s a potential problem to keep an eye on, but if companies are valued by how much cash can be taken out of them, discounted back to the present, then CSU has a lot of value.

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 Andrew Button has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Software. The Motley Fool has a disclosure policy.

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