When a fundamentally solid stock has fallen sharply, I want to know whether the decline reflects real issues with the business or simply a much more cautious market valuation. That distinction makes all the difference for long-term investors. For example, Constellation Software (TSX: CSU) looks like an interesting stock right now because its shares have suffered a big setback while several of the characteristics behind its long-term growth outlook remain firmly in place.
Let’s find out why Constellation Software’s underlying business strength could make its steep pullback an attractive entry point for patient long-term investors.
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Why Constellation Software looks attractive after the drop
In short, this Toronto-based tech firm mainly acquires and manages vertical market software businesses that provide mission-critical software and related services. Its six operating groups serve customers in more than 100 markets across the world, giving it exposure to a wide range of specialized industries.
After falling roughly 33% over the last year, CSU stock currently trades at $3,050 per share, giving it a market cap of $65 billion. The stock also offers a small 0.2% annualized dividend yield. Even as its stock has struggled lately, Constellation’s business performance remains solid, making it look undervalued to buy for the long term.
Business growth remains solid
Constellation’s revenue climbed 17% year-over-year (YoY) in the second quarter to US$3.3 billion. Acquisitions were the main contributor to that growth. At the same time, its organic revenue growth was 3%, or 1% after adjusting for foreign exchange movements.
Another positive factor came from its maintenance and other recurring revenue, which climbed to roughly US$2.6 billion in the latest quarter from US$2.1 billion a year ago. Constellation’s net profit attributable to common shareholders surged 386% YoY to US$274 million.
More importantly, its cash generation also improved as the firm’s cash flow from operations rose 10% YoY to US$477 million. Similarly, its free cash flow available to shareholders jumped 57% to US$345 million.
Acquisitions could keep supporting its long-term growth
For investors planning to hold CSU stock for years, Constellation’s ability to reinvest its cash into new businesses remains important. During the second quarter, the company completed acquisitions involving US$732 million in cash consideration.
This acquisition-driven strategy remains at the heart of Constellation’s business model. In fact, the company aims to invest all of its free cash flow available to shareholders in acquisitions that meet its hurdle rate. Quality acquisitions have already been the primary driver of its recent revenue growth, making continued dealmaking important to its long-term outlook.
Overall, Constellation’s rising revenue, improving cash generation, and continued acquisition activity make CSU an attractive long-term stock after its 33% decline. While its recent share-price weakness may test investors’ patience, its underlying business trends give long-term investors good reasons to consider buying this magnificent TSX stock and holding it for years.
