Finding and holding a 100-bagger, which is a stock that goes up 100 times in value, can be life-changing for any investor. Constellation Software (CSU -1.60%), a Canadian conglomerate of vertical market software (VMS) businesses, has returned over 100-fold for investors since its IPO back in 2006. The company has put up fantastic results for longtime shareholders with its decentralized acquisition strategy, but is it too late to buy shares of this business? Or is there still an opportunity for strong forward returns for Constellation Software stock? Let's take a look.

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What is Constellation Software?

Constellation Software was founded by Mark Leonard, an ex-venture capitalist, in 1995 with the goal of acquiring and managing small VMS companies. VMS is a category of software products that serve specific niches and industries. This is the opposite of horizontal market software products like Microsoft Excel that aim to serve as broad of an audience as possible.

Up until this year, management has solely focused on this task, acquiring hundreds of businesses over the last few decades. According to its website, the company now has over 15,000 employees and over the last 12 months generated over $4 billion in revenue. Each year, Constellation aims to use as much of its free cash flow from its current portfolio of businesses to acquire even more, which helps grow next year's free cash flow. Since the company has gotten so large, Leonard has delegated many of the acquisition decisions down to his operating managers, which enables Constellation to steadily increase the number of acquisitions it makes each year without overwhelming management.

So far, this strategy has worked out spectacularly for shareholders. Shares of Constellation stock are up 13,800% since its IPO in 2006. This has trounced the S&P 500 during this time period, which "only" returned 300% for index fund holders.

Management's new strategy

Over the past few years, Constellation's free cash flow has gotten so large that it has had trouble finding enough VMS businesses that fit its disciplined acquisition criteria. This is a good problem to have, but it shows that the single strategy of digging for small VMS businesses will not scale forever. Mark Leonard, still acting CEO, indicated as much in his February 2021 letter to shareholders, saying that Constellation is going to add not one but two additional acquisition strategies going forward.

First, it is building out a dedicated team for large VMS transactions (acquisitions in the hundreds of millions of dollars) that Constellation has strayed away from in the past. These types of deals typically have lots of competition, which could mean lower returns on invested capital for shareholders as bidders compete on price. but Leonard thinks adding this strategy will be better than just paying out a dividend with the cash sitting on the balance sheet. 

Second, Constellation is trying to grow a new "circle of competence," in the words of Leonard, outside the VMS industry. This was a surprise statement in the February letter, and would be the first move into another industry since Constellation's founding. Leonard gave no indications of what this strategy would be and only mentioned management is looking for "attractive returns, a sustainable advantage, and the ability to deploy large amounts of capital outside of VMS."

Why it's not too late

With the stock close to all-time highs, investors might think they've missed the boat in buying Constellation Software stock. But that couldn't be further from the truth. If management is able to get a large VMS acquisition engine going and eventually acquire three to five of these companies a year (Leonard estimates between 40 and 70 large VMS companies are sold annually), that could eat up more than $1 billion of Constellation's annual free cash flow. For reference, over the past 12 months, Constellation as a whole generated $1.3 billion in free cash flow.

Don't discount the new "circle of competence," either. Leonard and the Constellation team have proven to be some of the top capital allocators in the world, and opening up to more than just software could help really scale this business over the long term. At a market cap of $32 billion, Constellation trades at a trailing price-to-free cash flow of 24.6, which is entirely reasonable for a business of this quality. Don't expect future performance to match the last 15 years, but if Constellation can continue compounding its small and medium VMS acquisition machine, move into large VMS acquisitions, and build a business outside of software, the stock can put up strong returns for investors over the next 15 years, too.