Constellation Software (TSX:CSU) stock is easily one of the best growth stocks to own for the long haul. In the last decade, it’s up extraordinarily by about 1,440%, while total returns were approximately 1,630%, including dividends. In other words, an initial investment of $10,000 10 years ago transformed into about $153,940 without dividends. Including dividends, the result is about $172,950. These are market-crushing results compared to the Canadian stock market proxy: iShares S&P/TSX 60 Index ETF.
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Is it too late to get into Constellation Software?
As explained in the company’s second-quarter management discussion and analysis document, Constellation Software “acquires, manages, and builds vertical market software businesses. Generally, these businesses provide mission-critical software solutions that address the specific needs of its customers in particular markets.” This strategy has allowed it to generate substantial cash flow and revenue growth.
The company was founded in 1995. The founder, Mark Leonard, still runs as the chief executive officer of Constellation Software, which is much larger than when it started.
Its trailing 12-month (TTM) revenue of US$7.5 billion has doubled from the 2019 levels. It’s good to see that its gross profit also grew at the same rate. Its operating income increased 92% to US$1.1 billion with a TTM operating margin of 14.9% versus 16.7% in 2019.
Constellation Software has a track record of high return on invested capital (ROIC), which averaged just under 30% from 2015 to 2020. Although still high compared to many other businesses, the top tech stock’s ROIC has been on a decline, being about 16.4% in 2021 and 17.9% in 2022, with the TTM ROIC at 14.1%. This has investors concerned about the availability of fitting acquisitions for high returns. As the trend indicates, the company appears to be forced to lower its target returns on its more recent acquisitions.
Valuation
Additionally, at close to $2,716 per share, Constellation Software trades at a high multiple of about 35.6 times adjusted earnings. Investors are expecting it to continue to deliver double-digit earnings growth from its acquisitions of vertical market software businesses. Notably, the stock traded at about 18.1 times adjusted earnings 10 years ago.
In other words, the market has bid up the quality stock, as Constellation Software has executed with strong returns, including high returns on equity (ROE). Its five-year ROE is about 45%, but the ROE was about 29% in 2021, 37% in 2022, and 32% in the TTM. Like the ROIC, the ROE has also declined since 2021.
Is the stock worth the high multiple in today’s market environment? Analysts seem to believe the stock trades at a reasonable valuation. At the recent quotation, the 12-month analyst consensus price target represents a slight discount of 11%.
Investor takeaway
In a relatively high inflation and high interest rate environment, it may be more challenging to deploy capital for investing. Constellation Software stock could very well retreat to the $2,500 range in the near term. However, given the tech company’s top-notch track record, it could be worth it to build a position in the tech stock from current levels, especially since investors can buy partial shares on trading platforms like Wealthsimple.
