I've had my eyes on payroll and HR software provider Paycom (PAYC 1.24%) for a while. There's a lot to like about the company, and recent short-term issues have sent the stock tumbling from highs carved out during the pandemic.
The price still looks a bit too high, though, so I'll be staying on the sidelines for now. I would love to add the stock to my portfolio this year, but only if the valuation makes sense.
An efficient, customer-focused software company
Running payroll and handling HR processes are things that all businesses must do. When there's an issue, say with an employee's paycheck, the situation needs to be resolved quickly and efficiently. Paycom and its cloud-based software platform, which enables employees to enter and manage their own data, help free HR staff from many of the tedious tasks that can bog them down.
What stands out about Paycom to me is not what it sells but how it sells. The company's sales and marketing machine is composed of highly trained sales teams working out of dozens of locations across 28 states. It takes about two years for a sales office to reach maturity.
While this time frame limits how quickly Paycom can grow, the company's sales efforts are highly efficient. Paycom spent about one-quarter of its revenue on sales and marketing in its most recent quarter. In the world of subscription software, that's low. Salesforce, for example, spent 36% of its revenue on sales and marketing in its most recent quarter, and that was after cutting costs.
Another thing to like about Paycom is its focus on customer relationships. The company has been rolling out Beti, a product that enables employees to run their own payroll, over the past few years. The problem is that Beti works too well. Paycom noted in its third-quarter conference call that Beti had begun cannibalizing other services and sources of revenue. The company expects revenue to grow by just 10% to 12% in 2024, an outlook that reflects this cannibalization.
Beti's success is bad news for Paycom's short-term financial results, but it's great news for the company's relationships with customers. Paycom is saving its customers money and delivering more value. The best companies put the customer first, and that's exactly what Paycom is doing with Beti.
While Paycom's growth will be lackluster for a while, Beti can boost customer satisfaction and make it less likely that customers will move to competitors.
The stock looks too expensive right now
Shares of Paycom tumbled when the company reported its third-quarter results. The market was focused on the short-term downsides of Beti, sending the stock down around 40% in a single day.
Paycom stock has partially recovered since then, but it remains down nearly 60% from its pandemic-era high. Still, while I like the business, the valuation is a stumbling block.
Based on Paycom's full-year guidance, the stock trades for about 7 times sales. Paycom is profitable, even on a generally accepted accounting principles (GAAP) basis, thanks in part to its efficient sales and marketing tactics. The price-to-earnings ratio sits at about 35 right now.
One thing that makes it harder to justify paying a premium for Paycom stock is the uncertainty around the company's forecast. While the growth of Beti is playing a role, it's not clear if or to what degree competition is a factor. If Paycom's growth eventually reaccelerates, the valuation doesn't look unreasonable. But if it doesn't, then I'm not so sure.
I'd love to put Paycom in my portfolio this year, but the price has to be right. Given the risk of a more permanent slowdown, I'm reluctant to overpay for this otherwise solid software company.
