Tech stocks have been hammered recently, especially those trading at rich valuations. There's a good reason for that. It's expected the Federal Reserve will raise interest rates 3 to 7 times this year to combat rampant inflation, setting in motion a chain of events that should ultimately slow inflation by reducing business and consumer spending. Of course, less spending also means slower corporate revenue growth, which means those richly valued stocks now look even more expensive.
That being said, adding money to the market is the best move you can make during a downturn. Over the last 25 years, the S&P 500 has delivered an annualized return (adjusted for inflation) of 7%, despite weathering three bear markets. The S&P 500 Information Technology Index has performed even better, delivering annualized returns of 10.6%. That data makes a strong case for buying a few beaten-down tech stocks right now.
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For instance, Upstart Holdings (UPST 0.76%) and Paycom Software (PAYC 0.25%) have fallen 72% and 43.7%, respectively, from their 52-week highs, but these two growth stocks look like solid long-term investments. Here's why.
1. Upstart Holdings
Traditional credit evaluation models generally incorporate fewer than 30 variables when deciding creditworthiness, meaning many banks make lending decisions based on limited information. That's a problem because some creditworthy borrowers end up subsidizing those who default. The people who do pay off their loans are charged higher interest rates to compensate for those who will inevitably fail to make payments. While 80% of Americans have never defaulted on a loan, less than 50% qualify for prime rates.
Fintech company Upstart is on a mission to improve the consumer lending industry. Its platform captures over 1,500 data points per credit applicant, and it measures those variables against 21.6 million repayment events to quantify the risk for lenders. In doing so, Upstart helps its bank partners boost approval rates and lower loss rates, allowing them to offer lower interest rates to consumers. Compared to traditional credit models, research published by the Consumer Financial Protection Bureau suggests that Upstart's AI models boost approval rates by 27% and lower the average interest rate by 16%.
Fueled by that value proposition, Upstart's clientele is growing quickly. As of Dec. 31, 2021, Upstart had 38 bank partners, up 217% from 2020. Not surprisingly, that has translated into monster financial results. Revenue skyrocketed 272% to $846.7 million last year, and the company generated free cash flow (FCF) of $153.2 million, up fifteenfold from $10.1 million in the prior year.
More importantly, Upstart is well-positioned to maintain that momentum. It facilitated $11.8 billion in loans last year, but management puts its current market opportunity at $823 billion, a figure that includes both personal and auto loans. And that number could climb much higher if the company enters the $644 billion small business loans market or the $4.6 trillion mortgage origination market.
Currently, Upstart trades at 13.5 times sales. While that may not be cheap in a traditional sense, it is far cheaper than the company's average of 29.3 times sales since going public in December 2020. That's why now is a great time to add this monster growth stock to your portfolio.
2. Paycom Software
Paycom specializes in human capital management (HCM). Its comprehensive software suite helps organizations manage the entire employee lifecycle, from hiring to retirement. That includes applications for talent acquisition, time and labor management, and payroll, as well as data analytics tools that track employee usage of HCM tech to provide insights into workforce efficiency.
Paycom's capacity for innovation has helped it compete with larger rivals like Workday. For instance, in July 2021, it released Beti (Better Employee Transaction Interface), the first self-service payroll software in the HCM industry. Beti works through the same self-service app employees already use to manage timecards and benefits, allowing them to review their paycheck and correct any errors before payroll is finalized. That means human resources professionals spend less time on paperwork.
Paycom also places a lot of emphasis on customer retention. Each client is paired with a service specialist trained across the company's entire portfolio, creating a one-on-one relationship. That means clients can interact with the same knowledgeable individual whenever they need assistance. That strategy has been successful. Net retention reached 94% in 2021, continuing its steady climb from 91% in 2017, and the company hit 33,875 customers, up 9% from the prior year. As a result, revenue rose 25% to $1.1 billion, and FCF soared 45% to $193.2 million.
The HCM market is expected to grow at 8% per year to reach $28.6 billion by 2027, according to Global Industry Analysts. However, management believes Paycom has tapped just 5% of its addressable market. So, between steady industrywide growth and relatively low market penetration, Paycom has plenty of room to expand.
To that end, the company opened five new sales offices in the last five months, and management plans to continue building its presence in both new and existing metropolitan areas. As that happens, Paycom's comprehensive HCM platform and its customer-centric business model should fuel strong financial growth.
In terms of valuation, Paycom stock currently trades at 17.6 times sales, well below its three-year average of 23.2 times sales. That's why now looks like a good time to buy this stock.
