Constellation Software is one of my Top Picks, this investor says

The stock has done well to rally in recent months, but is there still more gas in the tank for Constellation Software? (Constellation Software Stock Quote, Charts, News, Analysts, Financials TSX:CSU) Portfolio manager Jason Mann says, yes, arguing that this Canadian software growth-by-acquisition story has lots more room to run.

“There’s always a risk they get too big and run out of acquisition targets, and that’s always been the knock against them,” said Mann, chief investment officer at EHP Funds, who spoke on BNN Bloomberg on Friday where he nominated Constellation Software as one of his three Top Picks for the year ahead.

“So far, it’s been a decade-plus that they’ve been doing this and they’ve yet to run out. And as we know, there are always new software companies forming and new areas to exploit on that front. I guess at a certain point, they’re going to be too big, but we think that’s a ways off,” he said.

Constellation is a vertical market software company which seeks out dozens of deals per year, buying up small businesses that have carved out a successful niche for themselves in a particular area and then mostly giving those business the autonomy to continue operating and growing. Constellation is then able to plow the resultant free cash flow back into new acquisitions and the process repeats. Last year, they bought 132 companies while in 2021 Constellation spent $1.5 billion in total on acquisitions.

As for the stock, CSU has been one of the best performers on the TSX over the past ten years, and while there was a pullback over 2022 in keeping with the general market turn away from tech and growth stocks, Constellation has rallied for a 23 per cent return since mid-October.

Mann says with tech companies having an off year in 2022, Constellation Software may be in a better position to profit on the M&A front.

“[The stock] is not cheap when looking at it on a conventional metric like earnings per share but it’s very cheap when looking at the return on equity. They’ve had greater than 30 per cent return on equity for more than a decade, every year. Last year, it was 60 per cent,” Mann said.

“Bottom line, they’re an unrelenting cash machine. The valuations have come off a lot in in software and that actually might help them. They probably have better opportunities in front of them with the sell-off in tech,” he said.