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Based on their current stock price, valuation, and potential risk we give Paycom Software Inc. (NYSE:PAYC) a hold rating. Although they are a leader in their industry and have beat revenues and EPS estimates on their last earnings report, we believe Paycom is currently overvalued, and investors should either hold the stock and wait to see if the price drops or wait to buy at a lower price if it does drop.
Paycom Software Inc. is an online Human Resources and Payroll services provider headquartered in Oklahoma City. Paycom services all 50 states and has 18 offices nationwide. Some of the largest companies that use Paycom’s services are MWW Group LLC, TerraCycle Inc, The American Red Cross, Confidential Record INC., and Blackfriars Group. About 4,719 different companies use Paycom’s services. They have around a 5% market share, which is small compared to their competitors such as ADP Workforce and Workday.
Although online payroll and human resource services have been around for more than a decade, its popularity has gone up in recent years especially during the pandemic. In 2021 Paycom saw record employee usage and have extended their employee platform with innovations such as Beti, which allows employees to do their own payroll. We believe the old practice of entering employee data manually will soon be overtaken by a new self-service system in which employees have a direct access to the database.
Paycom may have a smaller market share compared to some of their peers, but they are growing rapidly. In 2021 they’ve expanded their client size range from 5,000 to 10,000 and are successfully selling their product to larger companies with more employees. They recently opened a new sales office in Manhattan, as well as four other locations in Las Vegas, Jacksonville, New England and Southern New Jersey. Their employee count rose 28% year over year to 5,385 employees, and we believe this number will only grow in the future.
As mentioned earlier, Paycom recently came out with a new HR product called Beti that allows employees to do their own payroll. This product won top HR product of the year, and as a company Paycom ranked in the top 20 best places to work in the U.S. by Top Workplaces. In addition, they were named the top workplace in Oklahoma for the ninth consecutive year and were named the best company for women to work.
Strong Earnings & Strong Financials
Paycom came out with their Q4 2021 earnings report on February 8th of this year. They beat analyst estimates on both EPS and Revenues. They posted an EPS of $.84, which beat analyst estimates by $.07. They posted revenues of $284.9 million (up from $256.2 million in Q3 2021) beating analyst estimates by $9.14 million dollars. They beat analyst estimates of EPS every single quarter in 2021.
Paycom’s net income also increased in 2021 from $143.5 million in 2020 to $196 million. Over a 5-year period on average their net income has grown at a 18.77% rate. Revenue per share also increased a significant amount to $18.23 from $14.60 in 2020. Over a 5-year period this number has risen an average of 26.28%. Their EBITDA increased from $212.4 million in 2020 to $284.3 million in 2021, another impressive increase. The 5-year average growth rate for their EBITDA is 22.23% which is also impressive and shows the company has plenty of potential to grow.
Another big thing that caught our eye was their increase in cash and cash equivalents. In 2017 they had $46.1 million and in 2021 they had $278 million. The 5-year average growth rate for Paycom’s cash and cash equivalents is a staggering 52%. Their levered free cash flows have also increased significantly, rising 36,20% year over year. Their 5-year average free cash flow growth rate is 44.20%.
The big issue we see with Paycom is not their operations as a company. They have strong financials, a great potential for growth, and shown they know how to innovate and create new products. The big issue with Paycom is their valuation. The stock price is currently at $318.97. The stock price has fallen 9.55% in the last month, 38.5% over the last six months, and 18.87% in the past year. Since the start of 2021, the stock price has fallen 21.23%. Even after this decline in price we still do not believe Paycom’s stock is at an appropriate buy price.
PAYC’s Stock Price is Still Too High
We believe the biggest movers involving Paycom’s stock will be revenue growth and increasing their market share. Revenue growth will lead to more free cash flows which would allow Paycom to even further invest in their company and products. Increasing market share would undoubtedly have a positive effect, bringing more revenues in and strengthen the company’s financials. Paycom’s stock has fallen from its all-time high of $558.97 to a price of $313.90. Still, we believe the price is still too high for investors to purchase the stock. They have great growth potential and profit margin, but the current valuation is too high to be rated a buy.
Paycom has a current GAAP P/E TTM ratio of 90.5 meaning the stock is trading at almost 100 times earnings. This is 239.44% higher than the sector median GAAP P/E TTM of 27.27. Analysts estimate that annual EPS for Paycom in 2022 will be anywhere from $5.29 to $6.00, while in 2021 Paycom posted an annual EPS of $3.37 (a year-to-year increase from 2020 to 2021 of 36.99%.) With a 5-year average GAAP P/ E TTM of 90.2, the market seems as if they have no problem buying Paycom’s stock even at a high valuation. This metric has fallen significantly since November of 2021 when the GAAP P/E TTM was 187.56, but even with a forward P/E ratio of 56.90 the price is twice as high as the information technology sector median. At the end of 2016, the P/E ratio for Paycom was a much more favorable 38.23. The stock has only gotten more and more expensive as time has passed.
Paycom’s year over year revenue growth was a respectable 30.48%. In the past 5 years the average growth rate has been 26.44%. On their last earnings call, CFO Chad Boelte said their year-to-year total revenue growth for 2022 will be around 26%, a similar but smaller number than 2021. Analysts predict that on a forward-looking basis this number will be around 24.86%, which is still high for their sector. Paycom has a TTM operating cash flow growth rate of 47.95% and a FWD rate of 30.09%, which is a significant difference and indicates their operating cash flow will decline a great deal in the future. Other concerning growth metrics include their TTM and FWD ROE growth rates. Their TTM ROE growth rate of 18.02% is much higher than their FWD looking rate of 1.68%, and both metrics are quite lower than the information sector median. This indicates in the future their returns on equity will decline a fair amount as well. On a forward-looking basis, it looks as if Paycom is set to decline a great deal in their growth; Although even these forward-looking rates are still strong when compared to the Information technology sector. We believe Paycom will continue to grow but at a much smaller rate in the future, and we also believe the stock is priced too high despite strong growth metrics.
Although we believe the current price of Paycom is too high for investors to be buying the stock, Paycom is very profitable and knows how to make a high return. They have a very high TTM profit margin of 87.69% which is very attractive to investors. They also have high net income and levered free cash flow margins of 19.64% and 20.94% respectively. Their profitability is not concerning; Paycom has high returns on equity capital and assets of 25.45%, 18.73% and 4.10%. There is no doubt that Paycom knows how to profit. Only their assets turnover ratio is concerning and currently sits at .26%, 59.7% lower than the sector median.
Although Paycom has good growth and profitability metrics, as mentioned earlier we believe the price of the stock is simply too high for investors to get in right now. If you already own the stock, we believe it is a good idea to hold and see what happens in the future as the company is in a good position to grow their revenues and cash flows. However, there are almost no attractive valuation metrics that would constitute a buy rating.
Potential Risks and Downsides
As mentioned above, despite Paycom’s expensive valuation there are many parts of their business and financials that are attractive to investors. Although the price has fallen from its high of $558.97, we still believe that the current price of $317.32 is still too much. For this reason, we recommend investors who own the stock to hold it, and ones that do not own it to wait and buy the stock as the price continues to get cheaper. The potential risks investors take with our strategy can go two different ways; They can either miss out on gains by not holding the stock or lose money buy holding the stock and the price falls.
If investors decide not to invest in Paycom and the price does go up, investors could lose out on potential gains. Although this is not what we see happening, we do encourage investors to be cautious of daily and weekly prices as this stock is more volatile than most. With a beta of 1.48, Paycom’s stock is sure to be volatile in the future especially with a potential oncoming recession.
The next way investors could lose money with our strategy is by holding the stock and the price falls. Again, it is crucial for investors to check daily and weekly prices as this is a very volatile stock with a high valuation that could end up falling at any time.
Earnings per share and revenue are expected to drop on their next earnings release, and investors should consider this as well. There are many forward growth rates such as revenue growth and operating cash flow growth that are much smaller than their year over year rates, which means the company’s current growth will not be sustainable in the future. Investors should not only look at past performance, but potential future performance as well.
Overall, we are not potentially concerned with their performance as a company. It is the price that we see a problem with. At the current price, almost no valuation metrics are attractive. Although this is a growth stock and these stocks usually have higher valuation metrics, we also see Paycom’s growth slowing down quite a bit soon. Whatever investors decide to do, they should be cautious of the stock going either way; They could either lose out on potential gains or lose money by holding the stock and it drops in price.
Conclusion
As mentioned earlier, we give Paycom a rating of hold. Although Paycom has had great company performance the current price is simply too high, and we see their growth slowing down quite a bit within the next year. Based on next quarters earnings and revenue estimates as well as many forward-looking growth rates, Paycom simply does not look like they will be able to contain their growth at this rate in the future.
Many things in the current era we live in are turning digital, and the same can now be said about HR and payroll services. Paycom is at the forefront of this new digital service, and with many people now working from home Paycom is sure to be around for a long time and will continue to grow as more businesses adapt to this new digital age. With that being said, we think it’s a great time for people to think about investing in new forms of digital services such as Paycom; But the price is simply too high for many investors to want to take a risk on such a new type of business.
Investors should not only look at their future performance, but also at past price performance and the current price. We believe it is still far too high to be rated as a buy, but at the same time do love their potential and profitability as a company and would be happy to own the stock at a much lower valuation.
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