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Intro

I am always on the prowl for solid investment opportunities, and one so happened to cross my path today. I don't currently own any stock in this company, but my analysis is certainly pushing me in that direction! See below for more info...

Paycom Software appears to be a very strong company that has flown under the radar for me. It's still a bit pricey at $339 per share with a P/E ratio of 58, but the stock is also down -23% in the past year. I really like the fundamentals, and I believe this is a solid opportunity for the long-term. If you like the synopsis, it's just a matter of deciding when to buy.

Company Background

Paycom is a SaaS (software-as-a-service) company that delivers cloud-based human capital management solutions for small to mid-sized companies in the U.S. It was established in 1998 and is based in Oklahoma City. It offers a range of human capital management (HCM) functionality and data analytics from recruitment to retirement. Many companies use multiple systems for their human capital needs. Paycom, however, streamlines this process with its cloud-based HCM software that provides comprehensive functionality.

Delivering its software through the cloud allows it to magnify its gross profit margin. Gross margin is near 90% and well above the sector median. In contrast, Zoom (ZM) operated with a gross profit margin of 75% in the trailing twelve months. And Fair Isaac (FICO) operated with a gross margin of 78% during the same period. Revenue for Paycom has grown about 22% in the past year. It's also averaged a growth rate of nearly 25% over the past 5 years. Earnings have also incurred significant growth. Earnings have grown approximately 27% in the past year and an average of 17% annually in the past 5 years.

The SaaS business model also works heavily to the company's advantage, since their services are licensed on a contractual basis. This gives them good opportunity to scale quickly. Software solutions are delivered directly to customers without the need to partner with a distribution network or retailer. Paycom also appears to be growing at a very solid pace thanks, in part, to this business model. Digital transformation, along with the ongoing need and flexibility for companies to support working remotely, also continues to drive its solid growth. As remote and hybrid work setups persist, the need for a solution to virtually handle human resources increases.

Sustained Competitive Advantage

Paycom has invested heavily in its R&D (research and development) efforts, and that investment is paying off handsomely! The human capital management (HCM) industry is highly fragmented. Top 10 competitors hold less than 50% of the market. However, Paycom's innovative products have differentiated themselves from the rest. That has allowed Paycom as a company to also differentiate itself within the industry.

Paycom's solution was entirely developed in-house, and the company has never made an acquisition. In particular, Paycom's BETI product is a decentralized payroll system that has effectively modernized the human resource function for medium and large enterprises. It streamlines the process in contrast to offerings from competitors such as Workday, whose payroll process is more complicated being based on several different platforms. BETI allows HR to work more productively, with fewer personnel and a much more efficient payroll system.

A quick look at the charts below provide a telling story. They really demonstrate how Paycom's sustained competitive advantage is working in its favor as compared to key competitors like Workday, Zoom, and ADP. Growth in earnings (EPS) for Paycom is relatively superior in almost all respects. This holds true not only in terms of past performance but also relative to future outlook for earnings growth.

Paycom EPS Growth vs Peers

Margins also paint a pretty picture of superior market position for Paycom relative to its peers. And according to Fidelity, its healthy balance sheet helps underly its strength as a company. Long-term debt is being managed favorably, trending consistently below 50% relative to Equity since 2017, and declining. Debt-to-equity now stands at 32% with respect to the trailing twelve months. The company's fundamental stability remains evident with stable cash flow and low borrowings.

Paycom Profitability Margins vs Peers

Paycom Debt-to-Equity Ratios - 2017-2021

Research shows, however, that Workday has some significantly advanced technologies in machine learning and its cloud roadmap. It is also expanding into the ERP space with a 90%+ customer retention rate, making it a formidable long-term competitor. It appears that Workday's strategy is more so focused outside of the HCM space though. And although competitors such as Workday and ADP have sizeable resources to leverage, this will force Paycom to further reinvest in R&D, allowing Paycom to continue dominating long-term within the HCM space.

Buying Opportunity: Fundamentals Remain Strong

The chart above shows that Paycom's stock has performed exceptionally well. There is a clear upward trend over the course of the past 5 years. The recent pullback has caused a significant drop in the stock's price, presenting a buying opportunity (encircled area). The fundamentals of the company remain strong, with industry-leading innovative products and a sustained competitive advantage. It also has a strong customer base which has grown at a 13.8% compounded annual growth rate (CAGR) over the past 8 years.

Key profitability metrics remain strong, with return on equity (ROE), return on assets (ROA), and return on invested capital (ROIC) consistently being maintained at above-average and attractive levels. While we do see a dip in the nominal levels of ROE and ROIC in recent years, that's driven by additional paid-in capital hitting the balance sheet; net earnings remain consistently strong with the exception of FY2020 due to COVID.

Conclusion

Paycom's payroll application is the foundation of its success. According to management, all clients are required to utilize this application in order to access their other applications. As a result, the majority of revenues generated stem from payroll applications, but their revenue mix continues to evolve and will continue to do so as non-payroll applications are added to its HCM solution. Their strategy of increased employee usage makes sense to drive client satisfaction and client retention. Client adoption of new applications and increased employee usage have driven much of Paycom's revenue growth thus far, and it's expected to add to the trajectory going forward. Obtaining new clients is also a major strategic focus, driven by increased sales force productivity, expanding market presence in existing markets, and opening sales offices in new markets. With differentiated products that enhance HCM capabilities, I expect Paycom to further expand its market share.

Key Takeaways

If you're focused on the long-term, fundamentals remain in place for Paycom, and it is poised for continued growth and dominance. On one hand, Paycom is growing revenue more quickly, has significantly less debt on its balance sheet, and operates at a much higher gross margin compared to key competitors like Workday, ADP, and Zoom. Its unique product offerings afford a strong competitive advantage. The recent pullback in the market's valuation is good news for investors looking to buy into this company. Or even for existing investors, it represents opportunity to double-down and buy more.

On the other hand, the potential for an economic recession still looming may adversely affect company performance, as some companies begin to scale back on expenses. However, HCM software is almost a necessity in most companies, and I don't think any downturn in the economy will be prolonged. As long as Paycom continues to innovate and execute, and capture market share, I believe the stock will be an investment highlighted by a high compounded return for many years to come. Any further dip in the stock's performance would certainly make the option to buy-in even more attractive. Going long Paycom Software may prove worthwhile.

Disclosure/Disclaimer

The information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions.  I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP. The contents of this site and the resources provided are for informational and entertainment purposes only and do not constitute financial, accounting, or legal advice. The author is not liable for any losses or damages related to actions or failure to act related to the content on this website.