🗞 7 Stocks With Huge Operating Leverage

Happy Sunday!

Here’s what’s on the docket for this week’s newsletter:

• 📊 7 stocks with huge operating leverage

• 🇨🇦 Constellation Software’s Q1, AGM, and Valuation

Let’s dive in!

7 stocks with huge operating leverage

Businesses (especially tech companies) often hide their true profit potential by investing any cash they generate back into their own business.

For most tech companies, this means they are investing in people, product development, and marketing, which for the most part, tend to show up as expenses on the income statement.

Ultimately, for many fast growing tech companies, this can often mean that GAAP earnings understate the underlying profitability of the business.

Here are 7 companies that are finally flexing their true profit potential:

1. Salesforce

• 2019 Operating Margin: 3%

• 2024 Operating Margin: 20%

2. Palo Alto Networks

• 2019 Operating Margin: -4%

• 2024 Operating Margin: 13%

3. Uber Technologies

• 2019 Operating Margin: -66%

• 2024 Operating Margin: 8%

4. AppLovin

• 2019 Operating Margin: 2%

• 2024 Operating Margin: 47%

5. Palantir

• 2019 Operating Margin: -78%

• 2024 Operating Margin: 13%

6. Duolingo

• 2019 Operating Margin: -18%

• 2024 Operating Margin: 9%

7. NVIDIA

• 2019 Operating Margin: 26%

• 2024 Operating Margin: 62%

Partner Spotlight: Best Anchor Stocks

Constellation Software’s Q1, AGM, and Valuation

Constellation Software reported Q1 earnings and held its Annual General Meeting this week. Recall that the company does not host earnings calls; therefore, the AGM is pretty much the only moment when shareholders get a chance to hear from the management team. The objective of this article is threefold. I’ll first briefly discuss the Q1 earnings and the main points of concern, share my highlights from the AGM, and share some thoughts around the valuation.

Without further ado, let’s start with the quarter.

Constellation’s Q1

Constellation’s quarter was underwhelming to many, and for good reason. There were (imho) three main points of concern.

The first one was revenue growth. Revenue “only” grew 13% year over year, with organic revenue (FX adjusted) coming in at +2%. Many thought of this as very low because the reported organic growth number was 0%, but it’s not abnormal if we ignore the post-pandemic inflationary period. Management shared in the AGM that they still target GDP-like organic growth rates:

What stood out to me is that this was Constellation’s first quarter of sequential revenue decline in a very long time:

Capital deployment was the second (and arguably more worrying) point of concern. Constellation’s capital deployed into acquisitions was pretty light in Q1. Management deployed $133 million into acquisitions in Q1, or roughly $67 million excluding Topicus. Q2 is expected to be a considerably better quarter in this regard, with commitments for $427 million in acquisitions and still half a quarter to go.

It’s always the case for Constellation or Topicus that when capital deployment is light in any given quarter, people start to worry about the runway. While natural (because runways don’t last forever), plotting out quarterly cash deployed into acquisitions should help us see that it’s lumpy and that a weak quarter is not necessarily a good proxy of future capital deployment:

The TDLR (too long didn’t read) here is that one could have had similar concerns regarding capital deployment in Q3 and Q4 of 2020 or Q3 2021, and these concerns would’ve been quickly put to rest some quarters later. Experiencing lumpiness in capital deployment is normal and a characteristic that emerges when done right (opportunistically and in a disciplined manner). We don’t have to go far away to see a good example.

Meme of the Week

On Friday, financial giant Moody’s, downgraded their credit rating on the United States’ sovereign debt from AAA to AA1.

In a statement explaining the decision, Moody’s stated “This one-notch downgrade on our 21-notch rating scale reflects the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns”.

However, in an unforeseen turn of events, the White House simply rejected Moody’s downgrade late Friday night.

Didn’t know that was possible? Yeah, neither did anyone else.