5 Reasons to Add Paycom Software Inc. to Your Watchlist Today

Paycom's recent IPO may have gone unnoticed by the market, but here are five reasons to add this promising company to your watchlist today.

Jul 9, 2014 at 11:00AM

As an investor, HR is not what immediately comes to mind when thinking of investing opportunities. Paycom Software (NYSE:PAYC) -- which just went public in April 2014 -- provides cloud-based solutions for businesses to manage "the complete employment life cycle from recruitment to retirement." In other words, Paycom's solutions bundle payroll and HR tools into a single application. Per a recent press release from Paycom: 

Paycom's unrivaled proprietary software frees HR and others from compiling payroll, time and labor management and HR management reports by generating them on their behalf. All reports then can be exported in any format the company requests, including Excel, CSV and PDF.

Here are five reasons investors may want to put Paycom on their watchlists today.

1. Diverse base of clients (and high retention rates) 
Paycom serves more than 10,000 clients in all 50 states. None of these clients make up more than 0.5% of the company's overall revenue, meaning Paycom's success (or lack thereof) is not connected to any one client.

Even better, however, is Paycom's customer retention rate. Thanks to comprehensive service provided by the company through one-on-one assistance to each of its clients, Paycom enjoyed an average annual customer retention rate of 91% for the three years ended 2013. Insperity (NYSE:NSP) -- another business providing human capital management services -- has a slightly lower client retention rate of 81% as of 2013. 

2. Leadership and employee culture
Chad Richison founded Paycom in 1998 before turning 30 years old, and Richison -- now 43 -- remains CEO today. Richison owns 11% (or 5.67 million) of all shares outstanding and hasn't sold a single share since Paycom's IPO in April. 

Paycom was ranked the fifth best mid-sized company to work for in the U.S. in 2014 based on employee reviews on Glassdoor, a platform where employees anonymously rate their respective places of work. Paycom employees give the company a 4.1 rating as a whole, and Richison earns an 89% employee approval rating as CEO. 79% of Paycom employees would recommend the company to a friend.

Insperity employees, on the other hand, give Insperity a 3.4/5 rating on Glassdoor and CEO Paul Sarvadi receives an 81% employee approval rating. 64% of Insperity employees would recommend the company to a friend. While these numbers are certainly nothing to scoff at, Paycom has a decisive edge when it comes to employee culture as measured by reviews on Glassdoor. 

3. Opportunities for future growth 
Spending on corporate training increased 15% in 2013 to more than $70 billion and $130 billion worldwide. This is following a 12% increase in 2012 and a 10% increase in 2011. Paycom has benefited from these workplace trends in the corporate world with sales increasing an average annual rate of 27.05% over the past four years to $107.6 million in 2013. This also well outpaces the sales growth of Insperity, which has grown sales at a comparatively slower pace of 4.51% annually between 2011 and 2013. 

As of 2013, 86% of Paycom's clients were businesses with 50-2,000 employees. The company is particularly focused on expanding its clientele to larger companies with more than 2,000 employees, which currently comprise a mere 4% of Paycom's client base.

Paycom presently has 30 sales offices in 20 states, with plans to open six to eight new offices over the next two years to support both current and new clients. To put it in other words: The company's best days of growth are likely still ahead. 

4. Cash flow growth 
In 2011 Paycom was free cash flow negative, meaning expenditures totaled more than the business itself was producing. Since 2011, the company has expanded operating cash flow at an average pace of more than 37% annually to $23.72 million in 2013, helping Paycom produce $6.54 million in free cash flow in 2013. This is a noteworthy achievement for a high-growth company and boosts my confidence in the financial performance (and future) of the business.

5. Strong margin expansion 
In 2010, Paycom lost money by a small margin, essentially breaking even for the year. Since 2011, however, the company has expanded its profit margin from 2.5% to 7.2% in 2013. Growing margins helped Paycom expand earnings fivefold between 2011 and 2013.

Foolish bottom line 
Paycom currently trades at a P/S of 6.2 and a P/E of 183, with a market cap of approximately $680 million. The question for investors is whether Paycom has the ability to continue growing at rates to justify this lofty valuation. The stock doesn't appear "cheap" by traditional standards, but with a dynamic company culture and a very involved founder/CEO -- not to mention impressive growth and improving financial performance in a growing field -- I am not writing off Paycom. 

The fact that the general market has been largely uninterested in Paycom up to this point only further sparks my interest in exploring -- and potentially investing in -- this small but promising business. The stock will likely be volatile, particularly after the company's somewhat underwhelming IPO, but patient investors should keep a close eye on Paycom and follow the company's progress going forward. 

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[Article edited to correct Paycom's percentage of revenue concentrated with a single client]

David Kretzmann has no position in any stocks mentioned. You can follow David on his Foolish discussion board, Pencils Palace, on CAPS, or on Twitter @David_Kretzmann. Learn more about David's Pencils IRA Project at Fool.com. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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