The Toronto Stock Exchange has several software stocks that have generated 10 times returns in 10 years. One stock that showed resilient growth among tech stocks is Constellation Software (TSX: CSU). Some call it the Canadian Berkshire Hathaway.
Constellation Software: The Canadian Berkshire Hathaway
The name Constellation Software itself speaks about its business. It is a constellation of small vertical-specific software (VSS) companies, each having its own steady cash flows. It acquires companies in which it sees value and potential to be leaders in their niche space. The company places the acquired software companies under an umbrella of six operating companies, of which Topicus.com has gone public trading under the ticker (TSXV: TOI).
To give you an example of the niche and mission-critical application of the VSS, Constellation recently acquired Conduent’s Curbside Management (parking management systems for the public sector) and Public Safety (traffic management solutions) businesses. Such installed systems continue to generate regular maintenance fees.
Constellation Software stopped taking analyst calls a few years ago to keep its upcoming deals a secret from its competitors. If it were to make a competitive bid for a company, it would inflate the price and make the acquisition less attractive.
In a 2018 response, Constellation’s management explained that the company uses a mutually exclusive and collectively exhaustive (MECE) approach for every vertical. Mutually exclusive means no two companies it acquires have overlaps. Collectively exhaustive means that it acquires all possible applications in that vertical. Coming up with all permutations and combinations can give you a long list of potential acquisition targets.
Constellation allows acquired companies to operate individually and provide managerial help where required. In return, it takes a bite off its cash flow and reinvests that cash to acquire more companies, compounding its returns.
Constellation Software at its all-time high
Constellation has been acquiring companies since 1995. Suppose you invested $10,000 in 1995 in a stock that generated an average annual return of 10%. You reinvest the $1,000 return in a stock that gives a 10% return. Compounding at 10%, your $10,000 would be $144,000 in 2023.
Constellation has been reinvesting the cash flows of acquired companies. Hence, its stock price grew steadily at a compounded annual growth rate (CAGR) of 31.5% in the last 10 years. The math of compounding works like a snowball. As the snowball trickles down the mountain, it accumulates snow and grows its size.
Constellation’s stock price is in a long-term growth trend. The stock grew at a CAGR of 27.8% in the last three years (January 2021 to January 2024). On January 8, 2021, Constellation was at its all-time high of $1,647, up 36% from its pandemic low (March 2020). Had you waited for the stock price to fall, you would have missed the chance of doubling your money in three years.
Today, Constellation stock has made a new high of $3495.90 and has corrected slightly.
Should you buy, sell, or hold?
The major factor in compounding is time. Constellation stock is giving compounding returns of over 25%. If you already own the stock, you would benefit from holding it. The stock is growing at a 25%-plus annual return, which means it can double your money in over three years. The stock market is expected to revive and boost investments in growth stocks.
You can keep adding more shares of Constellation and compound your growth over time.
