Paycom Software: Innovation, Growth, Profitability Trifecta At A Discount

Investment Thesis

Paycom Software (NYSE:PAYC) is an incredible business that has seen its stock price move sideways over the past two years. This sluggishness is not due to any underlying issues at the company, but rather it being caught up in the broad valuation compression impacting higher growth names following Federal Reserve rate hikes. I believe the negativity around Paycom has been overdone and this is an opportunity to buy a high-quality compounder at an attractive valuation.

Paycom provides a market-leading, cloud-based human capital management software platform delivered on a subscription basis. It offers a comprehensive suite of applications to manage the complete employment life cycle, from recruitment to retirement.

In FY'22, Paycom put up an impressive year of 30% revenue growth and 42% adjusted EBITDA margins. The company is sustainably growing while maintaining industry-leading profitability.

While some may point to recessionary fears, I believe Paycom's fortress balance sheet with no long-term debt and over $536 million in cash allows it to smoothly navigate any bumps in the road. The company's vast market opportunity and land-and-expand strategy provide a long runway for growth.

Ultimately, I see Paycom as a core holding for any software-focused investor. The company will continue steadily compounding earnings over time. And with the stock trading at reasonable valuations, now represents an attractive entry point.

Robust Offerings

Paycom operates a “single database” HCM software platform delivered over the cloud on a subscription basis. Everything from recruiting, onboarding, payroll, time tracking, expenses, benefits, and performance management is handled within one integrated system.

This provides significant advantages over legacy HCM vendors or trying to stitch together point solutions. Data flows seamlessly between modules and analytics have a single source of truth. There is no need for complex integrations.

In 2021, Paycom launched an innovative self-service payroll product called Beti. This allows employees to manage their own payroll including time cards, fixing errors, and final approval. Paycom cited on its Q4 2022 earnings call that this is generating 90% labor savings in payroll processing for clients based on a study by Forrester.

Beti has already reached about 50% penetration of Paycom's client base as of Q4 2022. This shows the strong ROI clients achieve from Paycom's unique platform.

Sustainable, Profitable Growth

In 2022, Paycom grew revenue 30% to ~$1.38 billion. This level of growth is impressive for a company its size and it has proven durable even as revenue has scaled up. Despite fears of extreme slowdown growth has still remained in the mid-20s year over year in 2023.

What's more impressive is that Paycom produces adjusted EBITDA margins above 40%, with gross margins of over 87%. Most young software firms sacrifice profitability for growth. Unlike some that sell dollars for 90 cents, Paycom is very efficient with sales and marketing spend and generates significant cash while rapidly expanding.

This allows the company to self-fund its growth. In the trailing twelve months, Paycom spent over $170 million on R&D. It can invest aggressively in new products like Beti because it is not burning cash.

As CEO Chad Richison said recently, "We have 5% of the TAM today, however, our TAM has increased now that we've laid the groundwork for our global platform." Paycom is still early in its growth trajectory despite its large size.

Fortress Balance Sheet to Weather Any Storm

Some bears will point to recession fears as a risk for Paycom. But the company has a pristine balance sheet to handle any economic challenges.

Paycom has virtually zero long-term debt on its books and ended the last reported quarter with ~$536 million in cash. The company also produces high levels of operating cash flow, with ~$450 million generated in the trailing twelve months. Even in a downturn, Paycom has years of liquidity to smooth over any bumps.

The company caters mainly to mid-sized businesses, not startups prone to fail in recessions. Its customer base is diversified across geographies and verticals, reducing client concentration risks.

Paycom also sells a must-have product in payroll and HCM that is not easy for customers to rip and replace. Its average revenue retention rate exceeds 90%. High retention provides durability.

Competition Overblown

Some may point to Oracle, SAP and ADP as major competitors. But Paycom's modern cloud platform far outpaces the legacy on-premise offerings of those incumbents.

In its Q4 2022 earnings call, Paycom said it is displacing Workday, another cloud HCM provider, by bundling payroll, HR, and time-tracking functionality together.

No competitor can match Paycom's depth of integrated apps combined with differentiated employee self-service. Its single database architecture provides unique advantages competitors struggle to replicate.

While the HCM space is competitive, Paycom's product market fit and innovation with Beti give it a strong edge that will be hard for others to overcome.

Attractive Valuation With Upside

Given its growth, profitability, and balance sheet profile, Paycom should trade at a premium SaaS multiple. However, the stock currently trades at under a ~28x Forward P/E ratio.

I believe the market will appreciate the unique quality and growth characteristics of Paycom, awarding it a higher valuation multiple down the line. For a company of Paycom's caliber, the current valuation is quite attractive for long-term investors. Significant upside remains if the market rerates SaaS names to appropriate levels.

Conclusion

Paycom is a rare SaaS company that combines rapid growth with extremely high profitability. The company is led by visionary founder Chad Richison and operates in a massive HCM market with endless expansion potential.

While there are some macro concerns, Paycom's rock-solid financial position allows it to play offense in any environment. The company will continue taking market share with new innovations like Beti.

After its recent underperformance, PAYC stock trades at an undemanding level for its growth profile. The company is poised to deliver strong returns and this is an ideal time to start a position in a core long-term holding.