Should Paycom Investors Be Worried After Earnings?

Fintech software provider Paycom Software (PAYC -0.88%) recently released its latest earnings, and the stock has fallen considerably since. As a company that depends on American businesses for revenue, Paycom hasn't been immune to the COVID-19 pandemic, and its results certainly reflected that. In this Fool Live video clip, recorded on Feb. 22, Industry Focus host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss Paycom's results and whether investors should be worried. 

Jason Moser: Well, let's pivot over to Paycom here for a minute, Matt. I know this isn't the company we talk a whole heck of a lot about on the show, but we're going to change that because we're talking about Paycom today. I have a feeling that we will continue to talk about it more and more as time goes on, because the thing that stands out to me first and foremost, this is a quality business.

It looked like their earnings report which came earlier in the last week. We were off obviously last Monday, so we weren't able to cover it on that show, but wanted to cover it on this show. Paycom Software for those who don't know, they sell cloud-based HR software. Ultimately geared toward helping companies hire, and manage, and train, and pay their employees. I will say it is the pay part that really is the gist of their business today.

Most of their business is based on the payroll service. They do have a suite of offerings. They compete a little bit more with companies like Workday (NASDAQ: WDAY), for example, but it does really seem like payroll for now is the company's bread and butter. Interesting business from a number of different perspectives. It's got founder and CEO Chad Richison, who still owns just under 15% of the business. So that founder or leader, there's some good alignment there and shareholders can take solace in that.

I think in regard to the results; fourth-quarter revenue, $221 million, that was up just a bit over 14% from a year ago. It looks like earnings per share, looks like $0.84 per diluted share versus $0.86 a year ago. They are able to tread water here in what's been a difficult situation. Obviously, a tricky situation for a lot of businesses.

But really, I think that has probably played into Paycom's favor given the tech-driven nature of the business and the cloud offering that they provide. If you look at the actual business itself, the forecasts, they're are calling for here in the coming year, they're calling for 11.5% revenue growth for the current quarter, and growth for the full year of about 20%.

Now, it's worth noting, you look at this business historically over the last five years, they've grown revenue at a compounded annual rate of about 30% over the last five years there. I mean, growth is slowing down and that's to be expected. This is going to be a $1 billion revenue business here in 2021. They're going to cross that billion-dollar revenue mark. Big deal for them for sure.

Growth is slowing down and that's something to at least keep an eye on. I noted the stock is down about 11% since the release, and maybe that is, maybe there's some concern there with the growth slowing down a little bit, because it's not a cheap stock at least by conventional [laughs] valuation methods. Maybe price-to-sales is the more appropriate way to look at anything now. I'm only saying that half-kidding.

But if you look at Paycom, the business is profitable, it's cash flow positive, still trading at something like 165 times free cash flow and earnings. It's clearly a business where a lot of growth has been baked into that share price, and maybe that growth is slowing down a little bit and that's concerning the market. When you look at the competition in the space, something like an ADP (ADP 0.55%), for example, $72 billion market cap, makes 14 times the revenue of a Paycom, ton of cash flow.

Paycom right now, the opportunity there, they quote themselves having about a 5% market share on the call. So there is plenty of opportunity for them to continue serving that small to medium-sized business demographic on which they focus. But price does matter and maybe the market is looking at that growth here in the near term and wondering if the headwinds that they've been facing won't last a little bit longer.

But I think all in all a positive quarter, full-year total client count expanded to almost 31,000. That was up 17% from the prior year-end, so that growth was encouraging to see. Clearly they are doing something right. They are providing a service that customers like, because the customers keep re-upping and new customers keep signing up. All in all a positive quarter, but maybe a little bit of a valuation concern there and that's understandable.

Matt Frankel: The one thing I saw that maybe is concerning to investors, their revenue retention rate was 93%. We talk about a lot of these newer tech companies with subscription-based services having revenue retention in the 120%-130% range. There's a good reason for it. A lot of Paycom's customers, they went bankrupt during the pandemic. They focus on businesses. A lot of businesses didn't make it unfortunately. That's 93% of the revenue they came into the year with is still coming. They've added new clients, but the pandemic might have had a little bigger of an impact on the business than investors thought, and that could be concerning people as well.

Moser: Yeah, very understandable. Listen, 2020 was a difficult year for everyone, some more than others. Hopefully, we'll see 2021 here and things will start to turn around a little bit. My suspicion is this is a bit more of a near-term concern with Paycom, not something so business fundamental. Rather than just a bigger-picture economic driven type of situation for the business. I think it's one that has a pretty well-established track record of impressive growth. Again, you love to see a founder leader with those types of ownership stake still in the business.