Constellation Software (TSX:CSU) has proven its reputation as one of the most successful and consistent Canadian growth stocks on the market. The company’s unique strategy of acquiring and managing small, niche software companies has provided excellent growth and profitability over the years.
However, it’s also true that this very long and consistent growth trajectory has led Constellation’s stock price to soar and its valuation to remain high over time. I think this surge is warranted, but there are many who question whether the stock is still worth buying at current levels, or if the valuation is simply too rich.
Let’s dive into why I think this is a stock that’s still worth buying, even at close to 33 times forward earnings.
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Proven track record of growth
Many early-stage companies provide investors with the potential for sky-high growth rates and relatively long growth runways. These companies can trade at astronomical multiples for a while, until an overall picture of where long-term earnings will stabilize at materializes.
However, for a company like Constellation Software, which has been in the software sector for roughly two decades, this company is what I would consider to be a known quantity. Investors know what they’re getting when they put their capital to work in this software conglomerate.
The software firm’s ability to consolidate a fragmented software sector has led to tremendous growth, as Constellation’s management team continues to turn singles into home runs. By improving the return on invested capital of its acquired companies, Constellation can effectively create more value the more deals it does.
Constellation’s knowledge of the software landscape and the M&A game is its key competitive advantage. And with thousands of similar companies out there to acquire (and a rock-solid balance sheet that allows for more deals to take place over time), I remain bullish on the company’s growth trajectory over the next two decades as well.
High-margin, recurring revenue is the key
In addition to improving the underlying fundamentals of the companies it acquires, Constellation is focused on targeting various companies in niche industries without significant competition that utilize high-margin, recurring revenue models. In doing this, the company is able to retain its relatively high multiple, as investors continue to factor in growth acceleration into their models for this stock. Over the long term, investors who have priced in higher growth rates have been correct, and many investors simply aren’t willing to bet against this name.
That certainly makes sense to me, given the nature of Constellation’s overall business model. As the company’s acquisitions continue to outperform and spit off increasing cash flow, the company’s war chest to do additional deals grows. This allows Constellation to fuel its own acquisition growth, funding its deals from its own balance sheet without overburdening itself with debt.
That’s a virtuous cycle I think long-term investors can benefit from, by being a part of this growth. At current levels, Constellation Software stock still looks like a buy to me.
