Constellation Software (TSX: CSU) is one of Canada’s best-performing technology stocks. Up 271,000% since its listing in 2006, it has outperformed the market by leaps and bounds.
Key to Constellation Software’s outperformance has been CEO Mark Leonard’s management style. The founder has a somewhat venture capital (VC)-like approach, in that he grows his business by buying smaller companies.
Where Leonard differs from the typical VC is in his focus on financial soundness. Instead of buying companies whose founders seem to have “great ideas,” Leonard buys companies only when they already have positive revenue. This financial discipline has given CSU a better run than any VC fund in the time since it was founded. Also, Leonard achieves synergies by integrating acquired companies into Constellation Software. So, he delivers a double whammy of value for his shareholders.
The question for investors today is, “Can Leonard keep all this growth up?” When a stock rises hundreds of thousands of percentage points in a couple decades, it’s only natural to wonder whether it has gotten ahead of itself. On the other hand, such a stellar long-term track record as CSU’s is hard to argue with. In this article, I will explore the question of whether CSU is a buy, a sell, or a hold today.
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Performance
The first factor we can look at when evaluating CSU is its performance. In the last four quarters, CSU missed earnings expectations 75% of the time. That’s not a positive. On the other hand, it has compounded at very high compounded annual growth rates (CAGR) over the last five years:
- Revenue: 23% CAGR.
- EPS: 17.6%.
- Free cash flow (FCF): 35% CAGR.
The story was similar in the last 3- and 10-year periods. So, CSU has been doing well on growth.
Likewise, Constellation Software is very profitable. In the trailing 12-month period, it boasted the following profitability metrics:
- Gross margin: 36%.
- Net margin: 7%.
- FCF margin: 21%.
- Return on equity: 27.6%.
- Return on capital: 12.5%.
CSU’s growth and profit metrics are quite good. So, we can say that the company is performing well.
Future prospects
The next logical question to ask is whether CSU can keep up the excellent performance going forward. While the company has done well historically, tech companies are pretty pricey these days. It will be harder for CSU to find good deals that can move the needle in the future. So, I’d expect the company’s growth to decelerate going forward.
Valuation
Last but not least, we get to valuation. At today’s prices, Constellation Software trades at:
- 44 times adjusted earnings.
- 99 times reported earnings.
- A 3.5 price/earnings/growth (PEG) ratio.
- 7 times sales.
- 24 times book value.
These multiples are pretty high, even for a company that is growing quickly. The 3.5 PEG ratio, in particular, is a bit of a red flag. CSU is definitely not a value stock.
The bottom line
The bottom line on Constellation Software is that it has been performing incredibly well, but is also incredibly expensive. Overall, I consider CSU a hold. That’s not to say it won’t perform well, but rather, that its past rates of growth probably won’t continue indefinitely.
