Constellation Software (TSX: CSU) is often regarded as a tech stock. But its original business is that of acquisition and private equity. The company’s management keeps looking for small vertical-specific companies and acquiring them. Like private equity, Constellation allows acquired businesses to work as stand-alone entities and provides capital and operational support where needed. But unlike private equity, Constellation doesn’t sell the acquired company. In fact, it owns its revenue and cash flows.
The acquisitions generate cost synergies and add to Constellation’s revenue and cash flows. The key to its success is that Constellation never enters a bidding war that inflates the price and reduces the returns on the acquisition. Hence, the company remains secretive about which company it is pursuing.
Constellation acquires companies in an all-cash deal and funds most of the acquisitions from the cash generated by the acquired companies. In this way, it pays negligible dividends. However, the company also takes on debt if it sees an opportunity. As of June 2024, it had net debt of $2.2 billion.
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Where will Constellation Software stock be in a year?
Looking at Constellation’s business model, the company is harnessing the power of compounding, putting the money to work. It has grown its revenue during the 2022 tech downturn and 2023 business uncertainty. These downturns presented an opportunity for Constellation to buy companies at a discount as reduced technology budgets delayed contract renewals. However, the mission-critical nature of the software ensured the acquired companies’ minimum cash flows were not much affected by the technology budget.
The year 2025 could bring volatility as fears of recession loom. The US Fed has started an interest rate cut and the immediate reaction of the stock market was a rally. Constellation stock has surged 14% since June end. Next year, it could see tepid growth or a dip if recession fears materialize. However, if the North American economy avoids a recession, the stock could grow significantly in the medium term.
Where will Constellation Software stock be in three to five years?
The next three to five years could see accelerated growth in the tech space as the trends of the Internet of Things (IoT) and artificial intelligence (AI) at the edge materialize. The 5G rollout has created a platform for the next level of digitization. Constellation already has a presence in multiple niche verticals. The increasing investment in AI and cloud security could lead the way for growth in the software space.
Nvidia stock jumped 700% in 19 months after the generative AI boom in November 2022. Telecom companies are gradually transitioning to technology companies. In any tech boom, the first wave is of hardware to bring everyone into the ecosystem. The second wave is of software, which is still in the development phase as companies are finding use cases for AI and big data.
The speed at which Constellation’s stock price doubled has shortened from four years ($1,000 in 2018 to $2,000 in 2021) to three years and will shorten further. The stock could double to over $8,000 in the coming three years after considering a brief recession.
How to invest in this tech stock
A price tag of more than $4,400 might look expensive, but even one share could give your portfolio a boost. If you do not have the amount to invest in Constellation Software, you can buy a unit of the iShares S&P/TSX Capped Information Technology Index ETF (TSX: XIT). This ETF has its largest holdings in Shopify (27%) and Constellation (23%). While Constellation stock had an average annual return of 30% in the last 10 years, the XIT ETF returned 19.4%.
The XIT ETF’s returns and risks will always be lower than that of an individual stock, as it gives you the benefit of diversification.
