Paycom (PAYC) Analysis
A leading disruptor in HCM software with a massive addressable market.
In previous analyses, I’ve discussed less mature growth stocks - Confluent (CFLT) and Olo (OLO) to name a few. Today I want to talk about a more established company that has provided outstanding returns for shareholders. Paycom (PAYC) is an HCM software distributor that has absolutely crushed the market since its IPO (+1900%). While Paycom isn’t the most exciting company out there, it offers a software solution that every single company and government agency in the world can utilize, so the market opportunity is substantial. In this analysis, I am going to discuss several reasons why I own shares of this company and why I think this stock will continue to be a long-term winner.
Overview - What Do They Do?
Paycom is a leading provider of a robust, cloud-based software as a service (SaaS) human capital management (HCM) solution. It was originally designed as a payroll product, but grew into a tool to manage the entirety of an employee’s lifecycle - from recruitment to retirement. With Paycom, customers can identify candidates, on-board employees, manage time and labor, administer payroll deductions and benefits, manage performance, terminate employees and transition former employees to post-termination benefits. The platform offers a comprehensive selection of HCM solutions, which is a strong selling point for organizations of all sizes who don’t want to implement and manage a variety of HR products from multiple vendors. I have personally worked for multiple organizations where we used one program to submit PTO requests, another to manage employee information and yet another to fill out timesheets. Needless to say this is frustrating, inefficient for employees, and burdensome for HR. A single comprehensive platform is essential for organizations seeking to consolidate HCM workflows and improve efficiency of their human resources staff.
History of Innovation
In a competitive industry like HCM software, differentiation is vital to maintaining a competitive advantage. Paycom has managed to develop several industry-disrupting products that they believe could revolutionize HCM. In 2021, they introduced Beti, an employee self-service payroll solution. With Beti, employees cannot change their pay rate, but rather Beti enables them to walk through the payroll process, gaining insight into deductions and taxes while ensuring paychecks arrive error-free. This solution is beneficial to HR staff as well, as it cuts down on costs and labor and allows HR to focus on other matters - a common theme found in many of Paycom’s solutions.
Paycom has also developed Direct Data Exchange (DDX), an industry-first employee usage management analytics tool. This solution provides customers with real-time measurable insights into time and savings realized from employee usage of HR technology. DDX provides a ton of value to customers because it generates statistics that can be used to justify the value provided by its HCM vendor. In turn, Paycom can measure its value to existing customers and use this to market its products to future customers.
DDX and Beti are only the latest examples of the optionality this company has displayed since inception. Founded as an online payroll supplier, Paycom has evolved to provide countless solutions that span talent acquisition, time and labor management, talent management, HR management and, of course, payroll. Management has not only demonstrated the ability to adapt to new trends (cloud, mobile), but they have pushed these types of new solutions (DDX, Beti) to market in a first-mover fashion. Moving forward, I have confidence that this founder-led team will continue to innovate and bring revolutionary new products to the HCM market.
Strong Financials
Turning to financials, Paycom has been incredibly consistent for years. Annual revenue has grown by 25% on average since 2017, which includes a smaller growth figure in 2020, presumably due to the Covid impact on Paycom’s head-count subscription model. With revenue growth back up to 25% in 2021, and estimated 24% and 23% growth projected for 2022 and 2023, the company is expected to continue to perform in the coming years. It’s important to note that 98% of this revenue is also recurring. With a 94% revenue retention rate, Paycom has the ability to tinker with new products without damaging their primary, reliable revenue source. The company is also protected from the risk of customer concentration as they have over 17,700 different clients (based on parent company groupings).
Looking at a few other financial metrics, Paycom has consistently produced strong gross margins around 87% and operating margins around 20%. The company is profitable and has been growing earnings for years (with the exception of 2020, which was hampered by a tough first quarter during early-stage Covid). Generating $198 in free cash flow last year, they have amassed nearly $2 Billion in cash while taking on very minimal debt. Financially, the company is on solid footing.
Founder-Led Management Team Outperforming Expectations
CEO Chad Richison founded Paycom in 1998 and still owns 14% of the company today. Earning 89% approval on Glassdoor.com, he has created a positive workplace culture as employee reviews come in at 4.2 stars (out of 5). The company takes care of its employees, but it has also proved to be extremely friendly to shareholders. While many growth companies issue shares or convertible notes to raise cash, Paycom has a dilution rate of less than .01% over the last five years. Despite this, the company has continued to rake in profits and increase their cash holdings. As a shareholder, this instills a ton of confidence in the management team.
While I try not to focus too much on daily and weekly fluctuations in stock price, I do pay attention to earnings reactions because they do impact the performance of a stock. Long-term investing is difficult as it is, but extreme volatility caused by earnings releases can be tough for investors to handle. I am satisfied with strong, mediocre and even poor reactions, as long as the underlying business fundamentals have not deteriorated. Even if a company beats expectations, Wall Street will often react poorly if guidance comes in less than anticipated or slightly slowing growth can be expected. Macro environment plays a role as well - even if earnings and guidance are positive, bear market conditions will drag a stock down through earnings. However, what concerns me is a disastrous earnings reactions - see Docusign (DOCU). Back-pedaling or providing misleading guidance is a sign of bad management, and that’s not something I want to be involved with.
Aside from a hiccup in 2020, the company has consistently topped wall street estimates. This demonstrates that management has continually provided reasonable and transparent guidance while routinely outperforming their own expectations.
Large Market Opportunity for a Comprehensive HCM Solution
Looking at market opportunity, Paycom estimates that they have only penetrated around 5% of their total addressable market, demonstrating that the company still has a lot of room to grow. One of the their primary growth strategies is to station sales teams in potential marketplaces. As of the most recent annual report (February 2022), Paycom had established sales offices in 40 of the top 50 markets in the U.S. Management believes there is a lot of opportunity in these markets and in metropolitan areas without permanent sales teams.
Note: I don’t normally dive too deep into advertising because every company does it and individual marketing strategies generally aren’t noteworthy. However, Paycom employed a couple different advertising initiatives that actually led to my discovery of this company, so I wanted to briefly discuss why I believe marketing has been a competitive advantage. Here’s what they did:
To address a large international market opportunity, Paycom has strategically obtained naming rights for the Paycom Center, the home of the NBA’s Oklahoma City Thunder. I like this move because the NBA is currently the most popular sports league in the entire world and provides an excellent opportunity for international visibility, especially in Asia where NBA popularity is growing rapidly. The company has also rolled out a marketing campaign featuring Shark Tank businesswoman Barbara Corcoran, who went beyond the spokesperson role and applauded Paycom’s Beti technology at a sponsored webinar. Ultimately, I see these initiatives as strategic opportunities for exposure and new customer acquisition.
Historically, Paycom has been quite successful with small and medium-sized businesses, but they are beginning to target larger enterprises. These potential clients provide higher revenue per customer since subscriptions are billed by headcount, but management points out that these companies are more likely to develop in-house solutions for HCM than smaller and medium-sized businesses. It could potentially be a roadblock for acquiring some large enterprise customers, so this will need to be monitored over the course of future earnings reports. However, if Paycom can manage to land and upsell larger enterprise clients, the growth opportunities are immense.
Technicals and Valuation
Looking at the valuation, PAYC trades at about 18 times sales. Historically, this stock has traded at a multiple between 12x and 20x and is currently almost 50% off of its 2021 highs. Given the macroeconomic environment, I would not be surprised if this went lower in the near-term. The stock has established a support zone between 280-300, so this range looks like a great accumulation zone. Market conditions always need to be considered, but I will certainly be looking to increase my position if the market ends up pulling the stock lower.
Recap: Why Invest?
Paycom is one of my higher-conviction holdings and one that I believe still has a long growth runway. This founder-led company has only penetrated 5% of their total addressable market; a market that includes businesses of all sizes due to the scalability of the Paycom platform. The company has a strong balance sheet, generates a ton of cash through a reliable revenue stream and has delivered impressive growth without the need to take on a lot of debt. Paycom is also friendly to shareholders, averaging less than .01% annual share dilution over the last five years. Best of all, this company has demonstrated a ton of optionality, not only adding new products to its platform, but introducing new products to the industry as a whole. Paycom is still disrupting the HCM software industry, and if management continues to execute, this company can be a winner for a long time.
Position: 3.5%
P/E is 90 might that be a problem now that rates are rising ?