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Constellation Software (TSX:CSU) stock has risen dramatically in the markets. Up more than 20,000% from its initial public offering price and 229% over the last five years, it has really gone on a run. Today, however, the stock is expensive, going by some metrics. Trading at 111 times earnings, CSU is no bargain basement offering. However, it isn’t the most expensive tech stock in the world either.
In this article, I will explore the fundamental characteristics of Constellation Software stock so you can decide whether it is a fit for your portfolio.
$3,310
If you’d invested $1,000 in Constellation Software stock five years ago, you’d be sitting on a $3,310 position today. That is, the initial $1,000, plus $2,290 in capital gains, plus an extra $20 in dividends. Now, technically, CSU shares were trading for more than $1,000 five years ago, so you would have had to buy fractional shares to make this happen. Nevertheless, these numbers serve to illustrate just what a great return CSU has delivered for its shareholders over the last five years.
Is Constellation Software stock still a buy today?
It’s one thing to note that a stock went on a tear, but quite another thing to try to argue that it’s still a buy today. Constellation Software has grown as a business, but its stock price has risen even more. So, it has become significantly less attractive than it was five years ago from a valuation perspective.
At today’s prices, Constellation Software stock trades at the following:
- 111 times earnings (where earnings are calculated according to Generally Accepted Accounting Principles (GAAP))
- 69 times adjusted earnings
- 7.4 times sales
- 7.1 times book value
It’s certainly a pricier-than-average stock, going by the price-to-earnings ratio. However, its price-to-sales and price-to-book ratios are lower than those of most U.S. big tech stocks. CSU grew its revenue by 29% and its free cash flow by 49% in the trailing 12-month period. So, CSU’s overall combination of growth and value is not bad. 111 times earnings is high, but if you double your earnings, the ratio comes down to 55.5 in year one and then 27.75 in year two, etc. — assuming that the stock price doesn’t change, of course. Historically CSU’s stock price has fluctuated quite a bit, so this exercise is rather academic. Nevertheless, it goes to show that a lot of growth can make an “expensive” valuation today look cheap tomorrow.
The really relevant question here is whether CSU can keep the growth going. Trends rarely have much predictive value in themselves; what you need to know is whether the forces driving a trend will continue.
In CSU’s case, it appears plausible that they will. Constellation Software’s main competitive advantage is capital allocation (i.e., deciding where to invest money). Chief Executive Officer Mark Leonard has been described as a “genius” at this, having made hundreds of profitable investments during his tenure at Constellation. Over Leonard’s tenure, CSU’s earnings have grown by thousands of percentage points. Thanks to his track record, Leonard has become something of a Wall Street legend, his letters to shareholders being pored over by fund managers, just like Buffett’s. If Leonard can keep this going, then CSU may well continue to rise.
Foolish takeaway
Taking everything into account, I think that Constellation Software is a reasonably good buy today. It is not the “screaming buy” it was five years ago, but it’s still a decent value. There are much more modestly valued tech stocks out there, and I’d invest money into them before CSU. But CSU certainly isn’t the worst thing you could buy.
