Investing smart can give you better returns in the medium term than investing more. You don’t need to invest $10,000 to get $20,000. Getting the timing right to buy the dip can make this possible even with a $5,000 investment. But it is impossible to time the market. So how do you invest smartly in such a conundrum?
The trick is to choose fundamentally strong stocks, and identify a recurring pattern, such as seasonality, cyclicality, or simply cash flow accumulation. While you can’t time the market, you can look for stocks that are closer to their 52-week low and identify the reason for the dip. If the reason does not affect its future earnings potential, that is the stock to buy on the dip.
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A smart growth stock to buy with $5,000 right now
Constellation Software (TSX: CSU) is a resilient growth stock that grows its stock price by acquiring more vertical-specific software companies, which earn steady cash flow from maintenance fees. It funds future acquisitions from these cash flows. At times, it uses debt to fund acquisitions.
The stock is trading closer to its 52-week low
Constellation stock fell a sharp 11% between August 11 and 14 as the company’s second-quarter net income fell 68% to US$56 million due to a US$118 million foreign exchange loss. This loss is unrelated to the company’s business performance. Net income could improve as the US dollar value normalizes.
This dip presents an opportunity to buy Constellation stock, which is 6% above its 52-week low of $4,092.70.
Future earnings potential of Constellation Software
Constellation’s business model is based on the free cash flow (FCF) that is used to buy more companies. Its earnings per share and FCF have their ups and downs due to exceptional items, but the revenue continues to grow. Such exceptional dips only have a short-term impact
One such instance is that of January 2021, when Constellation spun off Total Specific Solutions and acquired Topicus.com. This event reduced its earnings per share (EPS) by 29% and FCF by 10%. However, Constellation stock has surged 179% since the January 2021 dip.
Those who waited until April 2021 to see the impact of the spin-off saw a 129% increase, and those who waited until December 31, 2021 saw an 86% jump in their invested amount. A delay of four months and 12 months led to a significant gap in the returns on investment.
Here again, nobody can time the market. However, Constellation’s long-term fundamentals were intact, and those who bought the stock despite the EPS decline enjoyed a better reward. Now is a similar opportunity.
Constellation has grown its revenue and FCF at a five-year compounded annual growth rate (CAGR) of 20.4% and 4.9%, respectively. If this growth continues, its revenue could grow to US$25 billion by 2029 from US$10 billion in 2024. Assuming the stock continues to trade at 6.2 times its sales per share, the stock price could increase to $7,858 by 2029.
A $5,000 investment right now
For $5,000, you can buy one share of Constellation for roughly $4,350. The remaining $650 can be used to buy the iShares S&P/TSX Capped Information Technology Index ETF (TSX: XIT). This ETF has 24.5% of its holdings in Constellation and 23.7% in Shopify. It also has exposure to other tech stocks such as Celestica, which is riding the artificial intelligence (AI) wave, helping you diversify risk. The ETF can be bought at around $75 per unit. Note that a 0.6% management expense ratio will be deducted annually from the value of the ETF.
