Constellation Software (TSX:CSU) is not a household name, but it is widely respected by tech investors around the world. The company has delivered an exceptionally strong long-term performance, rising by 13,000% in the market since the beginning of 2010. That performance was not an accident but the product of a shrewd capital-allocation strategy on the part of the company’s chief executive officer (CEO), Mark Leonard.
Leonard, who is in some ways like a venture capitalist, buys companies when they are still small yet generating positive revenue. He aims for acquisitions in the $5 million to $10 million range. He has acquired over 500 companies since his company’s inception in 2010. For the most part, the companies were sensibly bought, which is the reason why CSU stock has risen so much in the markets.
The question today is, “Can Constellation Software keep up the momentum?” While CSU’s 15-year run has been incredible, it’s natural to wonder whether Mark Leonard can keep it up. In this article, I will explore Constellation Software’s recent performance and attempt to determine whether this tech stock is still a buy today.
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Recent earnings
Constellation Software’s most recent earnings release was a miss, with revenue off by $50 million, adjusted earnings off by $2.54, and reported earnings off by $1.70. Headline metrics included the following:
- $2.5 billion in revenue, up 20%
- $164 million in net income, down 28%
- $517 million in operating cash flows, up 1%
- $362 million in free cash flow, down 2%
- Negative cash flows from financing and investing
As you can see, it was a mixed showing. The company’s revenue increased dramatically while its earnings and cash flow metrics either declined or barely budged. The company spent $197 million on acquisitions in the quarter, which explains the negative cash flows from financing and investing. However, the lack of earnings growth indicates that some recent acquisitions haven’t paid off yet.
High growth
Regardless of what happened last quarter, CSU has strong historical growth. Over the last five years, it compounded its revenue, earnings per share (EPS), and free cash flow at the following annualized rates:
- Revenue: 23.5%
- EPS: 6.92%
- Free cash flow: 13.5%
Pretty good growth, but note that earnings and cash flows increased less rapidly than revenues. On a “bottom line” basis, CSU’s five-year growth track record hasn’t been great.
A very steep valuation
Now, we get to the least-flattering part of the analysis for Constellation Software: the valuation multiples. Going by these, CSU is a mighty pricey stock, trading at the following:
- 47 times adjusted earnings
- 130 times reported earnings
- Eight times sales
- 29 times book value
This is a pretty steep price of admission for a company that has only compounded its earnings at 6.9% per year over the last five years. Now, it could be that CSU’s recent acquisitions have been truly stellar, and it’s about to unleash a new fountain of growth on both the top and bottom lines. But the recent history indicates otherwise.
Final verdict: It’s a hold
Taking everything into account, I think CSU is a hold. It is performing reasonably well but is extremely pricey. I see more value elsewhere. If you’re looking for Canadian companies with great compounding track records run by competent investors, you might want to look into something like Brookfield Corp as an alternative to Constellation Software. It delivers much more value per dollar invested than CSU does.
