Constellation Software (TSX:CSU) stock has outperformed the market this year, rising 20% when the TSX Composite Index has only risen 4.3%. The stock’s strong performance was partially due to tech stocks coming back into favour after a weak year in 2022. Last year, we saw a major bear market in tech stocks, driven by declining earnings and rising interest rates. This year, tech is coming back into favour, and that’s benefitting companies like CSU.
Still, the question remains…
Is CSU stock a good buy at today’s prices? After staging such an impressive rally, Constellation Software is now at an all-time high. That doesn’t mean the stock is necessarily overpriced, but it merits taking a look. In this article, I will explore some factors investors should look at before deciding whether to invest in CSU stock.
What CSU does
Constellation Software is a technology holding company that buys and grows small tech businesses. It usually buys businesses for $5 to $10 million and tries to buy them when they are already generating revenue. Over the years, this strategy has paid off and helped CSU grow from a small startup to a company doing $8.9 billion a year in revenue.
Constellation Software mostly buys enterprise companies — startups that sell vital software to companies that helps them manage their operations. For example, some of CSU’s companies sell point of sale software that helps stores take sales from customers. This kind of software isn’t glamorous, but it can be very lucrative, as businesses have to keep using it once they’ve started using it, unless they want to do a costly IT migration. So, enterprise software tends to lock in a lot of recurring revenue.
CSU’s latest earnings
We can look at CSU’s latest earnings to gauge how well its acquisition strategy is translating into profit. In its most recent quarter, CSU delivered the following:
- $1.85 billion in revenue, up 34% (most of which was due to acquisitions)
- $152 million in net income, up 23%
- $400 million in cash from operations, up 17%
- $290 million in free cash flow, up 8.8%
It was a pretty good showing. Although CSU’s growth in the period was driven entirely by acquisitions, it was pretty strong, and given that CSU isn’t known for overpaying, it doesn’t look likely that it was the result of juicing earnings through poor acquisitions.
Valuation
Finally, we get to what might be the most challenging part of the analysis for CSU: its valuation.
Constellation Software is a pretty expensive stock at today’s prices, trading at the following:
- 38 times adjusted earnings
- 79 times GAAP (Generally Accepted Accounting Principles) earnings
- Six times sales
- 23.9 times book value
- 31.50 times operating cash flow
This is an expensive stock, no matter which way you look at it. It isn’t necessarily all that expensive for its sector: many tech companies trade for 10 times sales or more. But it is more expensive than the average stock in the market today.
So, Constellation Software appears to be a pretty good company trading at a steep valuation. It’s profitable, it’s growing, and it has a good acquisition strategy, but you pay up for the privilege of owning all that. Perhaps if your time horizon is long enough, you may do well.
