Constellation Software is an overpriced momentum stock, this investor says

Canadian tech favourite Constellation Software (TSX:CSU) may have done well by its shareholders over the past decade, says Colin Stewart, CEO of JC Clark Limited, but the sharp investor is likely to see CSU for what it truly is now: an overpriced momentum stock.

Ahead of its second quarter earnings report arriving on Thursday, Toronto-based Constellation has been on a tear in 2018, already up 42 per cent. In April, CSU posted revenue of US$719 million for Q1, beating the consensus estimate of US$687.5 million, to go along with EPS of US$6.73 versus the Street’s $5.94.

The company has been a growth-by-acquisition story, having bought up over 250 businesses, many of them startups, over its 23 years of existence, now boasting a market capitalization of $23 billion.

Stewart says that its success is now disguising the fact that Constellation is overbought.

“There’s no doubt it’s a really well-run software company,” Stewart told BNN Bloomberg recently. “They’ve been really successful at consolidating and buying up smaller software companies, cutting a lot of those costs and really being able to garner significant synergies from those acquisitions. They’ve grown their EBITDA and free cash flow very significantly over the past ten years.”

“But the market has rewarded them for that with what we think is a very, very high valuation multiple,” he says.

In May, CSU’s share price passed the $1,000 mark, with the stock closing on Monday at $1081.62.

“I would just question, as they get larger, is it going to be harder to grow as quickly as they have in the past,” says Stewart. “I would put this almost in the category of some of these very expensive momentum-type stocks that have been driving the market, not only in the US but here in Canada.”

Much has been written about the heavy lifting being done by the so-called FAANG stocks, which together have contributed the vast majority of the S&P 500’s gains over 2018. Similarly, Canadian tech stocks like Shopify, Mitel, Constellation and CGI Group have driven the S&P/TSX Composite’s technology index up 23 per cent on the year.

“If the market conditions were to change and growth stocks were to falter in favour of value stocks, I think [Constellation] is a company whose share price could potentially suffer because investors have been rewarding it with what we think is a pretty aggressive valuation multiple,” Stewart says.