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Is Paycom Stock a Buy?

By Leo Sun - Apr 20, 2021 at 11:00AM

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The online payroll and human resource services provider could still have plenty of room to run this year.

Paycom (PAYC 3.94%) might seem like a risky stock to hold through a pandemic, since demand for its online payroll and human resource services would likely decline as businesses close down. And indeed, the stock dropped to a 52-week low about a year ago during the COVID-19 crash -- but then it soared more than 75% over the past 12 months. It's also rallied more than 1,000% over the past five years.

Let's see why Paycom remained resilient throughout the crisis, and whether or not this high-flying stock still has room to run over the next few years.

A man holds a roll of cash over blocks representing employees.

Image source: Getty Images.

How fast is Paycom growing?

Paycom, which was founded in 1998, was one of the first companies to provide fully online payroll services in the U.S. It then added additional services to its platform, including expense management software, document storage services, HR analytics software, and mobile management apps.

Paycom's revenue rose 30% to $737.7 million in 2019. Its adjusted net income grew 31% to $204.6 million, and its adjusted EBITDA increased 32% to $317.9 million. It ended the year with an annual retention rate of 93%, compared to 92% in 2018 and 91% in each of the previous six years.

Paycom's revenue rose 14% to $841.4 million in 2020, even as the pandemic throttled demand for its payroll and HR services. Its adjusted net income dipped less than 1% to $203.5 million, but its adjusted EBITDA still grew 4% to $330.8 million as its annual retention rate held steady at 93%.

Why has Paycom kept growing?

Paycom's growth has held steady because it generates 98% of its revenue from recurring subscriptions. Most of its clients didn't cancel their subscriptions, even as they struggled with slower sales during the crisis.

A man works on charts on a laptop.

Image source: Getty Images.

Paycom's total number of clients rose 17% to 30,994 for the full year, so it's still gaining new customers at a faster rate than it's losing existing ones. During its latest conference call, CEO Chad Richison noted that the "pandemic's impact on our pre-pandemic client revenue remained stable."

Paycom's cloud-based software already enables companies to manage and pay their employees remotely, so it easily withstood the shift toward remote work.

That's why the usage of its new Manager-on-the-Go app, which lets managers monitor and supervise their employees from their phones, hit an "all-time high" during the year.

Paycom's operating margin contracted in 2020 due to higher pandemic-related expenses, but its gross margin still expanded 20 basis points to 85.9%. That expansion indicates it still has plenty of pricing power against younger rivals like Workday (WDAY 1.98%), which posted another net loss last year.

A rosy outlook with frothy valuations

Paycom expects both its revenue and adjusted EBITDA to rise about 20% this year as the pandemic passes. It also anticipates its full-year gross margin to remain steady at 85%-86%, and plans to continue repurchasing shares to offset the dilution from its stock-based compensation.

Paycom has repurchased 4.1 million shares since 2016, but the total number of outstanding shares has declined by less than 1% over the past five years. Therefore, investors shouldn't expect Paycom's buybacks to reduce the stock's high valuations anytime soon.

Paycom's stock trades at 73 times forward earnings and 24 times this year's sales. Those valuations are high compared to those of other SaaS (software as a service) companies with comparable growth rates. Salesforce (CRM 1.92%), which expects to more than double its annual revenue by fiscal 2028, trades at 56 times forward earnings and eight times this year's sales.

Workday, which is expected to generate just 16% sales growth this year, trades at 13 times this year's sales. ADP (ADP 1.52%), a traditional payroll and human resources services giant that is likely losing business to companies like Paycom and Workday, trades at just 29 times forward earnings and six times this year's sales. However, analysts expect ADP's revenue to rise just 2% this year, with flat earnings growth -- so that lower valuation might be justified.

Is it the right time to buy Paycom?

Paycom's stock looks expensive, but I believe its early-mover's advantage in the cloud-based payroll space, along with its robust growth rates, sticky subscriptions, and high gross margins all justify that premium.

Paycom might seem exposed to the rotation from growth to value stocks, but it's also a reopening play that should grow faster after the pandemic ends. Therefore, this stock still looks like a solid investment even after its multibagger gains over the past few years.

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Stocks Mentioned

Paycom Software, Inc. Stock Quote
Paycom Software, Inc.
$291.17 (3.94%) $11.05
Automatic Data Processing, Inc. Stock Quote
Automatic Data Processing, Inc.
$213.23 (1.52%) $3.19
Salesforce, Inc. Stock Quote
Salesforce, Inc.
$168.20 (1.92%) $3.16
Workday, Inc. Stock Quote
Workday, Inc.
$142.35 (1.98%) $2.77

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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