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Constellation Software has become too expensive, this portfolio manager says

Constellation Software
Michael Simpson

Canadian tech favourite Constellation Software (Constellation Software News, Stock Quote, Chart TSX:CSU) has posted impressive gains over the first half of the year, including a string of new highs hit over the past two months.

So what’s not to like about CSU? The multiples, for one thing, says Michael Simpson, senior vice-president and senior portfolio manager at Sentry Investments, who advises investors to stay away until the stock cools off.

Constellation Software is up an impressive 42 per cent for 2019, with the stock easing into a nice uptrend of late, hitting higher highs and higher lows since February. But posting healthy returns is nothing new for CSU, which has been a top performer on the TSX for a good decade now —who wouldn’t want to have owned Constellation when it was $30.00 back in April of 2009?

But count Simpson among the skeptics who see darker days ahead for this growth stock.

“This is a company that has been around for a while. They consolidate different software companies and they’ve got a number of verticals,” says Simpson, to BNN Bloomberg on Thursday. “Pretty good balance sheet. Our read is no debt.”

“[But] the market is fixated on growth — in Canada certain investors like growth by acquisition stories,” he said. “[Constellation] trades at about 27x earnings and about 20x price to cash flow, so we just find it too rich for our valuation.”

In its favour, CSU has relatively low volatility for a tech stock, while the company has been consistently growing its top and bottom lines over the years. For 2017 and 2018, for example, Constellation grew its revenue by 17 per cent and 23 per cent, respectively, with three per cent organic growth in 2017 and two per cent in 2018. The company’s adjusted EBITA grew by 17 per cent to $621 million in 2017 and then grew by another 22 per cent to $757 million over 2018.

Yet, Simpson feels that along with being a pricey stock, the company’s business model is puzzling.

“Part of their model is that they leave the individual software companies so that there’s no consolidation of centralized services and we find that a bit odd,” said Simpson. “[With] other software companies that consolidate, you can get much higher margins.”

“They’ve done well over the years, but unless their valuation comes down, we’re not going to invest in it,” he said.

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About The Author /

Jayson is a writer, researcher and educator with a PhD in political philosophy from the University of Ottawa. His interests range from bioethics and innovations in the health sciences to governance, social justice and the history of ideas.
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