Constellation Software Inc (TSE:CSU) shareholders, and potential investors, need to understand how much cash the business makes from its core operational activities, as well as how much is invested back into the business. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. I’ve analysed below, the health and outlook of CSU’s cash flow, which will help you understand the stock from a cash standpoint. Cash is an important concept to grasp as an investor, as it directly impacts the value of your shares and the future growth potential of your portfolio.
What is free cash flow?
Free cash flow (FCF) is the amount of cash Constellation Software has left after it pays off its expenses, including its net capital expenditures, which is what the company needs to spend each year to maintain or grow its business operations.
There are two methods I will use to evaluate the quality of Constellation Software’s FCF: firstly, I will measure its FCF yield relative to the market index yield; secondly, I will examine whether its operating cash flow will continue to grow into the future, which will give us a sense of sustainability.
Free Cash Flow = Operating Cash Flows – Net Capital Expenditure
Free Cash Flow Yield = Free Cash Flow / Enterprise Value
where Enterprise Value = Market Capitalisation + Net Debt
Constellation Software’s yield of 3.16% indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential. This means investors are taking on more concentrated risk on Constellation Software but are not being adequately rewarded for doing so.
Does Constellation Software have a favourable cash flow trend?
Can CSU improve its operating cash production in the future? Let’s take a quick look at the cash flow trend the company is expected to deliver over time. In the next few years, the company is expected to grow its cash from operations at a double-digit rate of 40%, ramping up from its current levels of US$596m to US$836m in two years’ time. Furthermore, breaking down growth into a year on year basis, CSU is able to increase its growth rate each year, from 16% next year, to 21% in the following year. The overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.
Given a low free cash flow yield, on the basis of cash, Constellation Software becomes a less appealing investment. This is because you would be better compensated in terms of cash yield, by investing in the market index, as well as take on lower diversification risk. However, cash is only one aspect of investing. Now you know to keep cash flows in mind, I suggest you continue to research Constellation Software to get a more holistic view of the company by looking at:
- Valuation: What is CSU worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether CSU is currently mispriced by the market.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Constellation Software’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.