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.
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:
This is a highly competitive field as seen in this competitive landscape diagram below (taken from a Paylocity (PCTY) 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.
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.
It is worth noting that founder and CEO Chad Richison still owns 13.9% of shares outstanding.
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.