Paycom Software (PAYC 1.24%) is a leading provider of human capital management (HCM) software and has been putting up impressive growth lately. The company's cloud-based Beti platform provides a suite of human resources and payroll management tools that have been resonating with business customers, helping the business grow sales 28% year over year and net income 30% in the first quarter.
But even with impressive sales and earnings momentum, Paycom stock has gained just 5% amid this year's broader rebound for tech stocks and continues to trade down 41% from its high. What comes next for the cloud software specialist? Read on for a look at bullish and bearish catalysts that investors should consider before going all in on the stock.
Green flag: Great margins and expansion opportunity
Paycom posted net income of $119 million on revenue of $452 million in the first quarter, working out to a 26% margin. On a non-GAAP (adjusted) basis, the software specialist recorded $143 million -- representing a roughly 32% adjusted net income margin.
For a business that's still growing at a brisk pace, Paycom is managing to serve up impressive profitability. And with an 85.6% gross margin last quarter, the company is recording results that stand out even among typically high-gross-margin subscription software businesses. What's more, its fantastic bottom-line results show that the HCM software provider doesn't need to break the bank when it comes to sales and marketing.
Following the 30% annual revenue growth that it posted last year, Paycom expects to increase sales roughly 25% this year to reach roughly $1.71 billion. Given that many other cloud software companies are guiding for far more substantial sales growth deceleration this year, management's sales guidance looks pretty encouraging. And with Paycom's high levels of operational efficiency helping to deliver such great margins, there's a good chance that the business will be able to record net income growth above 20%.
The earnings growth picture becomes even more attractive when extrapolated further out. Paycom believes that it's currently capturing just 5% of its total addressable market (TAM). Based on recent software sales momentum and the fact that its products are generally held in high regard, there's a good chance that the software specialist can continue to gain share in its current market -- and moves to expand in new geographic segments could expand its TAM significantly.
Red flag: Potential recession threatens its growth-dependent valuation
Paycom's business appears to be quite strong, and it's got promising expansion potential ahead, but that doesn't necessarily guarantee that its stock will see strong gains above current pricing levels. Trading at roughly 42.5 times this year's expected earnings and 11.5 times expected sales, the company's valuation is highly growth dependent.
PAYC PE Ratio (Forward) data by YCharts
With the U.S. possibly on track to slip into recession sometime this year or next, Paycom could be facing a significantly more challenging growth environment.
The fact that most of the company's sales base is built around subscription revenue should help to establish something of a performance floor, but the business might have a much more difficult time attracting new customers and building relationships with existing clients if overall macro conditions worsen.
Cloud software stocks will likely see big sell-offs if investors pivot away from growth stocks again, and Paycom's specialization in the HCM market puts it at risk of performance slowdown in the event of recession.
Is Paycom a smart buy right now?
Despite the possibility that worsening macro conditions will depress the business's expansion momentum, I think that Paycom is a worthwhile buy for long-term investors. The software company is showing that it can deliver robust earnings growth while serving up margins that many mature businesses would be jealous of, and there's still plenty of expansion potential ahead.
Even though its growth-dependent valuation opens the door for some turbulent trading, the economics of the business are excellent. If you're not deterred by the potential for pricing volatility in the near term, Paycom has the makings of a smart buy-and-hold investment.
