Constellation Software (TSX:CSU) is one of Canada’s most successful tech companies. Since it went public in 2006, it has grown its earnings by over a thousand percentage points, and its stock price by an astounding 19,744%. If you’d invested $10,000 in CSU on its initial public offering date and held to today, you’d be sitting on a $1.95 million position. That’s an incredible return. But it doesn’t necessarily mean that CSU stock is a buy right now. History is replete with examples of stocks that ran up, sometimes over long periods of time, only to come crashing down later.
In this article, I will explore the question of whether CSU stock is a buy today.
Business basics
The first step to understanding CSU’s stock is understanding its business. Over the long run, fundamentals drive stock prices, so you need to know what a business does to make an informed investment in it.
CSU is a technology holding company that operates somewhat like a venture capital (VC) firm. Like a VC firm, CSU invests in companies when they are still young and fairly small. However, CSU operates differently from a VC firm in the following ways:
- It does not seek “exits”; instead, it buys whole companies and aims to keep them long term.
- It does not operate as a fund.
CSU typically buys enterprise software companies when they are already generating revenue — unlike many VCs, it does not buy at the “idea” stage. It has been fairly successful with this approach, having grown its revenue and earnings by 1,000% since 2013. As I’ll show in the next section, this is not a track record driven by early success that later stopped, but an ongoing track record of compounding.
Recent earnings
Constellation Software’s earnings have been pretty strong lately. In its most recent quarter, the company reported the following:
- $2.1 billion in revenue, up 23%
- $177 million in net income, up 30%
- $8.36 in diluted earnings per share (EPS), up 30%
- $513 million in cash from operations, up 60%
- $367 million in free cash flow, up 70%
Overall, it was a pretty good showing. And as mentioned in the previous section, the 11-year trajectory has been good as well. As long as Mark Leonard can keep finding good companies to buy, CSU will keep succeeding. In fact, it may keep succeeding without acquisitions, using just the organic growth of the companies it already owns.
Valuation
Now we get to the one factor that may not be so flattering to Constellation Software:
Valuation.
At today’s prices, CSU trades at the following:
- 67 times earnings
- Seven times sales
- 34 times book value
- 34 times operating cash flow
The stock certainly isn’t cheap, but then again, not many stocks have CSU’s long-term earnings growth trajectory. You pay for quality. Given the combination of great fundamentals and an expensive stock price, CSU is probably the kind of stock you’d want to own but at a modest portfolio weighting. The company is growing, but much of the growth is already being paid for.
