Constellation Software (TSX:CSU) stock has been one of Canada’s best-performing tech stocks over the years. Since going public in 2006, it has risen 24,480% in the markets, making it a best-in-class Canadian compounder.
What has made Constellation Software such a success?
Most who have studied the company say it’s CEO Mark Leonard’s approach to capital allocation. Leonard operates somewhat like a venture capitalist (VC), buying companies when they are small. Unlike traditional VCs, though, Leonard does not seek “exits.” Instead, he seeks to integrate acquired companies into CSU’s existing operations. Also, Leonard prefers to buy companies when they are already earning revenue and, ideally, profit, something not all VCs insist on. Based on this, we could say that Leonard’s capital-allocation approach is more “disciplined” than that of typical VC investors.
In addition to having a great compounding track record, Constellation Software has also built up a number of useful services. These include enterprise applications in industries like marketing, utilities, retail, financial services and healthcare. The number of Constellation’s services is too high to list them all individually. One example is ATEX, a European content management system developer serving the marketing and media industries.
So, Constellation has been a big success historically. But is it a buy today? Like most stocks with illustrious track records, Constellation Software trades at high multiples. So, we need to look at what it has going for it today, before we can decide whether it is a buy.
Recent earnings
We can start by looking at Constellation Software’s most recent earnings release. The release was largely a miss, with both adjusted and reported earnings being off analyst estimates by considerable margins. Some highlight metrics include the following:
- Revenue: $2.84 billion, up 15%.
- Earnings: $56 million, down 68%.
- Cash from operations: $433 million, up 63%.
- Free cash flow: $220 million, up 21%.
The release disappointed investors, but the growth rates in cash flows were pretty good.
High growth
Over the longer term, Constellation Software has been a real grower, with revenue, earnings and free cash flow (FCF) compounding at 24%, 13.6% and 16.6% annualized over the last five years. Over the last 10 years, the growth rates were 20%, 16.7% and 19.9%, respectively.
Strong profit margins
In addition to growing pretty quickly, Constellation Software has pretty high profit margins. In the trailing 12-month period, it boasted a 36% gross margin, a 6% net income margin, and a 21% FCF margin. Additionally, it had a 22% return on equity and a 13% return on capital. So, the business is pretty profitable.
A steep valuation
Last but certainly not least, we need to take a look at CSU’s multiples. At today’s price, CSU stock is certainly not cheap, trading at 45 times adjusted earnings, 113.6 times reported earnings, 6.15 times sales, 22 times book and 30 times cash flow. All of these multiples are pretty steep, especially the price-to-book ratio.
Foolish takeaway on CSU stock
Taking everything into account, I consider CSU stock a low conviction buy, one I’d hold at a low portfolio weighting. It continues performing quite well but is rather pricey.
