CONSTELLATION SOFTWARE: the best Canadian compounder?

Constellation Software, (“CSU”) on the TSX, is a diversified Canadian software company that primarily invests in vertical market software. CSU has been an extremely successful Canadian company and has been a TSX stock market darling for years. Just pull up their long term chart and see for yourself!

Notoriously successful at re-deploying free cash flow, under the leadership of their founder Mark Leonard, CSU has been generating out-sized returns for shareholders for more than two decades. Mr. Leonard, who writes an always interesting shareholder newsletter each year, (a link to the latest letter at the bottom), has focused on disciplined capital allocation and high Return on Invested Capital “ROIC”. This focus has allowed CSU to re-deploy capital into high return, asset-light software businesses which have allowed CSU to compound their earnings and drive their stock price higher.

Since CSU’s specific definition of ROIC doesn’t quite match Morningstar’s (which is what we like to use), we decided to look at a simple proxy:

ROIC = FCF as a percentage of a simplified average LT assets

This calculation, which is presented in the above graph is calculated as follows:

ROIC proxy = FCF / average LT assets where,

LT assets = (Balance sheet gross PPE + goodwill + intangibles) + (cash flow PPE additions + acquisitions)

Per this calculation, since 2008, CSU has been able to generate a FCF return on investment greater than 25% in all years. An extremely impressive result. This type of return is certainly hard to maintain, but we’ll keep watching as Mr. Leonard does his best!

Mr. Leonard releases his annual shareholder letters each year in April, so look out for it next month! A great read, indeed.

Cheers from LongTrend

CSU Shareholder letters: