Some of the top stocks of the last decade have been in the software-as-a-service (SaaS) sector. Paycom Software (NYSE:PAYC) is no exception. The payroll and human resources (HR) software provider has returned over 750% for shareholders in the past five years, outpacing the S&P 500 index during that timespan. The company continues to take market share within the human capital management market over competitors like Oracle (NYSE:ORCL) and Paylocity (NASDAQ:PCTY) with its comprehensive SaaS solutions.
Should you consider adding Paycom Software stock to your portfolio right now?
It manages a key part of every business
Paycom's products help companies manage the employee lifecycle, assisting in everything from recruitment to retirement. Its core product is its payroll solution. Through a self-serve application, employees are able to manage timecards, benefits, expenses, and more from a single location. The company is continually improving the payroll process for its customers, recently launching a product called Beti that allows employees to manage payroll themselves (as opposed to having HR or the expense department file everything). Beti, along with Paycom's other products, helps HR and accounting departments become more efficient in managing their company's expenses.
Outside of payroll, Paycom has software products for talent acquisition, time and labor management, and HR management. It targets businesses with 50 to 5,000 employees and makes money through recurring revenue subscriptions and one-time fees when its customers send in forms, filings, and adjustments.
Growth has been consistent and retention is strong
With its recurring revenue model, Paycom has enjoyed steady growth since going public in 2014. In 2013, Paycom generated $107.6 million in revenue and has grown its annual revenue every year since then, with 2020 revenue coming in at $841 million. In the company's latest earnings report, management guided for between $1.017 and $1.019 billion in 2021 revenue. If it can hit the midpoint of this guidance, Paycom will grow revenue by 21% this year.
Unlike many of its software brethren, Paycom has been able to grow sales while maintaining strong profit margins. Net income has been positive every year since 2013, which is impressive considering that Paycom is on pace to grow its sales by almost 10 times from 2013 to 2021. In 2020, the company had $143 million in net income. Its net income margin was lower than previous years in 2020, likely due to COVID-19 related disruptions, but from 2016 to 2019, net margin hovered around 30%. Investors should expect net margins to bounce back within the next few years.
One reason Paycom has been able to grow while also consistently generating profits is the reliability of its customer base. Over the last three years, Paycom's customer retention has been either 92% or 93%, meaning that once a company starts using its products, there is only a small likelihood of it leaving each year.
Valuation is creeping up
While Paycom's business has continued to impress, the stock has gotten quite expensive. With a market cap of $22.6 billion, Paycom trades at a forward price-to-sales (P/S) ratio of 23 based on management's 2021 revenue guidance. Assuming it will eventually get back to a net margin of 30%, that gives Paycom Software a forward price-to-earnings ratio (P/E) of 94 -- and that is being generous, as it likely will take a while for it to get back to 2019 margin levels. For reference, the S&P 500 trades at a current P/E of 34.5, meaning that Paycom's forward earnings multiple is almost three times the current earnings multiple of the broader market index.
Should you buy Paycom stock?
Paycom has been a great-performing stock of the past, and there's no reason for existing shareholders to sell just because the valuation has run up. But at such a high forward P/E, unless you believe this business can compound revenue at 20% for another decade while expanding its profit margins, now does not look like the optimal time to buy Paycom stock.