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What are we looking for?

Valuations for 10 Canadian application software companies trading on the Toronto Stock Exchange.

Last week all of the FAANG stocks (Facebook Inc., Apple Inc., Amazon.com Inc., Netflix Inc., and Alphabet Inc.’s Google) reported earnings. Some came in below to well below expectations (Amazon, Alphabet, Netflix), while other surprised to the upside (Facebook, Apple). In Canada, our technology sector is dominated by software companies such as Shopify Inc., Constellation Software Inc. and CGI Inc. What is our valuation outlook for them?

The screen

We used StockCalc’s screener to select the 10 largest application software companies on the TSX. We then used our valuation tools to calculate fundamental (or intrinsic) valuation for each stock to see whether it is undervalued or overvalued compared with its price.

Overview of the techniques used:

· Discounted cash flow, or DCF value, is a valuation technique in which cash-flow projections are discounted back to the present to calculate value per share;

· A price comparables, or price comps, technique values the company on the basis of ratios from selected comparable companies;

· An adjusted book value, ABV, is calculated by multiplying book value per share by its 10-year average price-to-book ratio.

· If we have analyst coverage, we look at the consensus target price.

More about StockCalc

StockCalc is a fundamental valuation platform with tools to calculate and report on value per share for thousands of public companies listed on major North American stock exchanges.

What we found

TSX-listed application software companies

CompanyTickerMkt. Cap. ($ Mil.)Recent Close ($)StockCalc Val. ($)Diff (%)DCF Value ($)Price Comps ($)ABV ($)Analyst Tgt. ($)Div. Yld. (%)1Y Rtn. (%)
ShopifySHOP-T69,214549.531,079.1996.41,458.48884.701,565.791,362.66n/a-62.1
Constellation SoftwareCSU-T42,8462,021.871,797.13-11.11,333.471,785.511,650.473,096.680.312.4
CGIGIB-A-T24,550102.44112.439.8125.58252.8491.11127.00n/a-5.8
Open TextOTEX-T13,95251.4563.0922.690.8667.6954.0590.272.1-9.2
Ceridian HCM HoldingCDAY-T10,93872.0573.762.44.8069.8692.14134.00n/a-37.9
Descartes Systems Grp.DSG-T6,76279.7972.36-9.337.6073.5164.01136.47n/a1.5
Lightspeed CommerceLSPD-T4,26028.7160.33110.19.2987.91255.3485.14n/a-66.6
KinaxisKXS-T3,921142.16140.96-0.851.31117.91171.19254.71n/a-10.3
Enghouse SystemsENGH-T2,00736.1346.9530.046.9563.6150.0650.672.1-36.8
Converge Tech. Sol.CTS-T1,8508.6310.8625.88.7222.0620.6113.43n/a40.1

Source: StockCalc

Application software is a broad category that includes software for the masses as well as specific applications for individual clients or vertical markets. Firms in this category tend to channel cash flow back into growth instead of paying dividends. Analyst consensus estimates are higher than many of our models for the firms shown primarily owing to the analysts’ higher forward growth projections. (For fast-growing companies, our methodology often shows a lower valuation because our focus is on projected cash flow, not top line revenue growth.)

You can see in the accompanying table the percentage difference between each stock’s recent closing price and its intrinsic value. The “StockCalc Valuation” column is a weighted calculation derived from our models and analyst target data. Let’s look at two of these companies:

Shopify will report financial results on Thursday and analysts expect US$1.6-billion in revenue for first quarter 2022 versus US$1.4-billion actual revenue in the fourth quarter of 2021. Shopify’s stock price has come down considerably in the past year (about 62 per cent) even with rising revenue and earnings per share. Our weighted average valuation is considerably higher than Shopify’s current price with all of our models at least 50 per cent higher than current price. The company announced plans for a 10-for-one stock split on April 11 that includes a founder share for chief executive Tobi Lutke that maintains his voting control at 40 per cent. Special share classes tend to be a drag on both the valuation and stock price given they are a controlling vote, implying the balance of voting shares are less effective to non-effective.

Lightspeed Commerce Inc. has seen its share drop by 44.3 per cent so far this year and it is down 81.9 per cent from its high close of $158.93 on Sept. 22. In a September report, Spruce Point Management accused the company of misleading investors on future growth potential. In response, Lightspeed said the short-seller’s report contained “numerous important inaccuracies and mischaracterizations.” In February, a new chief executive was appointed. Has the stock price overshot to the downside? Three of our four models are much higher than current price and our DCF model is well below the current price but positive, which is encouraging as the company is still losing money. Jean Paul Chauvet, the new chief executive, is projecting 35- to 40-per-cent revenue growth both from internal and acquisitions. Lightspeed is slated to report its fiscal fourth-quarter financials on May 19.

Investing involves risk. StockCalc accepts no liability whatsoever for any loss or damage arising from the use of this analysis.

Brian Donovan, CBV, is the president of StockCalc, a Canadian fintech based in Miramichi, N.B.

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