Constellation Software (TSX:CSU) has soared 54% in 2023! That contributes to a 308% total return over the past five years and a 1,906% return over the past 10 years. With hindsight, there has never been a bad time to buy Constellation’s stock. If you look at its chart, it has steadily and consistently risen at a near 30-degree angle.
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Constellation Software is a great stock to buy on pullbacks
While the above may be true, investors can often improve returns by buying opportunistically. Constellation is not safe from general stock market volatility. In fact, over the past three years, Constellation’s stock has fallen twice by more than 20%, and nine times by more than 6%.
Despite rising 54% this year, Constellation stock still saw eight instances where its stock fell by 4% or more. The point is, even the most powerful and steady growth stocks give investors buying opportunities periodically. However, today may not be that time.
The stock is pricey at today’s price
Constellation stock is not exactly cheap right now. With a price of $3,280 per share, it is trading just down from all-time highs.
CSU trades with a price-to-earnings (P/E) ratio of 35. That is close to its five-year high. Certainly, the P/E ratio might not be the best measure for Constellation. Given that it largely grows by acquiring many small software companies, it has a large non-cash amortization expense that substantially reduces its earnings per share.
Management provides a direct metric of the cash it generates called “free cash flow available to shareholders” (FCFA2S). It believes that this is its most important key performance indicator (KPI).
Based on that, Constellation trades with a price-to-free cash flow ratio of 23.9. While that remains below its five-year mean, it is the highest valuation the stock has traded at in a year.
Constellation has a formula for smart capital allocation
Constellation has continued to perform better than many market commentators expected. The company has a formula to acquire niche vertical market software businesses, maximize their cash flows, and re-invest the cash back into more businesses.
So far, the formula appears intact. Constellation acquired over 100 new businesses into its portfolio this year. That equates to $2.3 billion being reinvested into new specialized software businesses. If it can maintain its 15-20% hurdle rate of return on these acquisitions, it should continue to see strong growth in cash flows in 2024.
Over the last 12 months, it has increased revenues by over 28%. FCFA2S has risen by 32% in that time. The company continues to operate with exceptional strength. Its diverse mix of essential software businesses appears resilient, despite weakness in the economy.
Will Constellation Software stock keep soaring?
Constellation is undoubtably an exceptional business. Its track record of strong returns, smart management, and great capital allocation make it a top business in North America.
Meanwhile, the company has been spinning-out parts of its business to shareholders. Chances are good that further spinouts will occur in the future. The prospect for strong total returns ahead remains very much intact.
I would not be a buyer of Constellation stock at the recent highs. However, any inevitable pullback would make for a great buying opportunity. You will have to think long-term with a stock like this, but patience will likely be significantly rewarded.
