Paycom: Crushed Tech Stock With 20% Revenue Growth, 40% Profit Margins

Summary

• Paycom stock is down 40% from 2021 highs.
• Unlike typical tech companies, Paycom is highly profitable with 40% adjusted EBITDA margins and 21.6% GAAP margins.
• Management is guiding for 24% revenue growth this year in spite of a tough macro environment.
• I discuss the risks and opportunities in the stock price today.
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Paycom (NYSE:PAYC) is a highly profitable tech stock with a payroll and HCM offering. PAYC stock has pulled back significantly from the 2021 highs as valuations had gotten ahead of themselves. The stock is now trading at 2020 levels in spite of what appear to be sustained top-line growth and strong profit margins. PAYC has a strong balance sheet with $400 million in net cash. While PAYC operates in a crowded field, I expect the resilient revenue growth rates and high profit margins to help pave the way to higher stock prices. I am initiating coverage of PAYC at “buy.”

PAYC Stock Price

PAYC came public in 2014 but was founded in 1998 amidst the dot-com bubble. In spite of the recent volatility, PAYC remains a home run investment for those who stayed with it over the long term.

Data by YCharts

PAYC remains around 44% lower than 2021 highs but the stock may have been caught up in the tech bubble.

PAYC Stock Key Metrics

PAYC is a payroll and HCM solution, helping its customers manage its employees’ work life cycles, ranging from payroll to time-off requests. PAYC can be considered an enabler of the digital transformation of human capital management. You can see how the Paycom app looks below:

Paycom

This is a highly competitive field as seen in this competitive landscape diagram below (taken from a Paylocity (PCTY) presentation).

Paylocity Investor Presentation

PAYC appears to have found a niche catering to mid-tier companies. PAYC itself points out the simplicity of having an all-in-one offering which is a typical selling point for their target market (and has some positive ramifications on their financial profile as discussed below). For a deeper look at the PAYC business model, I can recommend this article by Robert Chan.

In its most recent quarter, PAYC delivered 30% YOY revenue growth to $370.6 million, with recurring revenues making up $364 million of that. Unlike the typical tech company, PAYC is highly profitable, generating $163.9 million in adjusted EBITDA and $80 million in GAAP net income. Those figures represent 44.2% and 21.6% margins, respectively.

How is PAYC so profitable? The secret appears to be in the ultra-lean R&D and S&M cost buckets which, while both growing at robust rates YOY, represented far lower percentages of revenue than seen at other tech companies.

PAYC ended the quarter with $400.7 million in cash versus $29 million in debt. The combination of a net cash balance sheet and positive cash flow generation enabled PAYC to repurchase $100 million of its stock in the full year. PAYC has $1.1 billion remaining under its share repurchase program and I expect the company to utilize this program given the strong profit margins.

Looking ahead, management has guided for 25.7% YOY revenue growth in the first quarter and 23.7% YOY revenue growth for the full year. Adjusted EBITDA margin is expected to remain strong at 41.2% for the full year.

It is worth noting that during a period in which it seems like every tech management team is talking about artificial intelligence, PAYC management has taken a different route, stating on the conference call that they “believe AI for the sake of AI isn't really valuable to the client.” While I suspect that PAYC might not yet be a household name for tech investors, it may soon become one as it is one of the few tech companies able to sustain such strong revenue growth rates alongside robust profit margins.

Is PAYC Stock A Buy, Sell, or Hold?

While PAYC remains more than 40% lower than all-time highs, its valuation is not yet distressed. It is highly likely that Wall Street remains bullish on the stock’s prospects in large part due to the aforementioned combination of top-line growth and GAAP profitability. PAYC was recently trading hands at around 10x sales - a reasonable valuation but definitely at the high end of its growth cohort. For reference, Okta (OKTA) trades at around 6.4x sales despite a similar growth outlook.

Seeking Alpha

But PAYC’s valuation looks more reasonable when we judge it on the basis of earnings. PAYC was recently trading hands at around 38x earnings - a reasonable valuation considering the low-twenties revenue growth rate.

Seeking Alpha

It is worth noting that founder and CEO Chad Richison still owns 13.9% of shares outstanding.

2023 DEF14A

At recent prices, I find PAYC to be still buyable. I am skeptical that profit margins can expand meaningfully from here but that might not matter so much. Based on 30% long term net margins and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see PAYC trading at around 10x sales - meaning that the stock might deliver annual returns similar to its revenue growth rate.

What are the key risks? Ironically, the reason why investors love this stock may prove to be the source of its risk. PAYC’s high margin profile might end up being a long term red flag, as it might be implying that the company is not investing heavily enough in innovation. There seems to be some evidence of this in the company’s 3.6 star Glassdoor rating, which is arguably low for newer tech companies. While such a strategy can lead to great profits in the near term (as we are witnessing right now), it may subject the company to vicious disruption over the medium and long term. Due to that reality, I would not be surprised to see the company show an acquisitive appetite moving forward in spite of the company not being very acquisitive in recent years. PAYC may seek to broaden its product portfolio in order to reduce the potential for disruption, a similar playbook as Salesforce (CRM). But such a strategy might not come to the benefit of shareholders, as any resulting M&A might prove costly. PAYC has a strong balance sheet and cash flow profile, but management might use that as reason to justify a large acquisition that requires the company to take on considerable debt. If this were to occur, I would expect the stock price to experience material multiple compression in order to account for the increased financial risk. On the other hand, if the company can show operating leverage and a commitment to its share repurchase program, then I could see the stock sustaining solid returns over the medium term. I rate PAYC stock a buy but note that the valuation remains elevated versus tech peers and the risk of management execution issues is not insignificant.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of OKTA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am long all positions in the Best of Breed Growth Stocks Portfolio.

Comments

[down_to_finance]

massive layoffs and competition will drag this thing down a lot. I'm seeing sub 200

[hoosbobby]

@down_to_finance Haven’t seen anything about layoffs. Source?

[Lorem Ipsum DSA]

So if (I mean "when"... No, I mean "as") AI begins to replace some employees, is this bearish for Paycom?

[Dividend payer]

Love the company, fantastic software, great service….but the valuation is still very lofty despite the correction….and NO Dividend

[Grower not Shower]

To your point on risks and Paycom investing in innovation. It certainly looks like not all the solution pieces are included but will be added to the offering. With most their customers in that mid-market segment it'll be interesting to see how long it'll take them to get a foothold in other countries. Either way it looks like Paycom is leveraging their lean R&D to meaningfully grow the TAM.

"Paycom is now able to expand access to users in more than 180 countries and is available in 15 languages and dialects."

www.businesswire.com/...

[Dividend Streamer]

With Paychex and ADP trading at 26-28x forward earnings with mid teens earnings growth, it would seem that Paycom’s high 30’s PE along with 25-30% growth is somewhat comparable.

The payroll and HCM businesses are a very good place to be. Fantastic growth, sticky client base and even fairly defensive during an economic downturn.

[Ghost of Graham]

Thanks for the article which brought PAYC to my attention.

It screens well on fastgraphs, but that valuation...there no doubt will be multiple compression in the long term, so your return is the earnings growth fighting a falling PE. I prefer them to work together, like with STNE.

There's no telling where the multiple could land - 35x earnings, 30x earnings, less. Kind of reminds me of Amazon. But Amazon is worse, where both the earnings and the long term multiple are anyone's guess.

In terms of payments infrastructure, GPN is selling at 10x earnings or less. Hard to see much long term multiple compression there with earnings likely over 12% at least for the next decade.

The problem with buying great companies at a reasonable price is that you risk compression and you have no margin of safety. The problem buying good companies that are very cheap is that, as Monish says, you have to sit with the discomfort surrounding why it was so cheap in the first place. I prefer this short term discomfort.

[Julian Lin]

@Ghost of Graham I agree that the multiple is rich here, given where other stocks stand.

[lbeachmike]

@Ghost of Graham Thanks for reminding me about StoneCo. I took a fresh look and it looks great! Why the depressed valuation? Looking ahead two years, it looks like an easy double without any multiple expansion. Why is Paycom given a premium multiple? I have a position in Paycom - it looks like moving that money into StoneCo may make sense.

[Ghost of Graham]

@lbeachmike paycom probably has its multiple because is has a clean record of growth and maybe because it's more US based, for all I know. But I don't know the company.

Stone Co has some knocks against it which it is still recovering from. It launched a loans program with its SMBs which it got taken advantage of with, basically, and had to pay off the losses. That's why the negative earnings in several recent quarters. The positive there is they pulled the loan business, fixed it, and are now bringing it back into the mix, so another revenue stream in the next quarters onwards.

Stone is also in Brazil, which has suffered economically for years. To me this is mostly due to the strengthening of the USD after Trump got elected, which makes Brazils GDP look worse than it is. The strong USD also hurts Stones earnings, which are partly reported in USD.

The interest rates in Brazil are also very high, which is either a sign of impending recession or a growing economy, or both. High interest rates encourage savers to save instead of spend, so it's not good for payments to merchants, which is like 85% of Stones business, something around there.

Last reason for low valuation is the new leader who is a green socialist anti business type of guy.

I love the company, it's like 12% of my portfolio and I expect it will do exceptionally well with its crazy revenue growth rates and vrry cheap valuation once fears shift to new media cycles. But... we'll see.