Investors are being encouraged to consider Paycom following a significant drop in its share price.
Typically, seeking value in stocks that have declined by more than 70% at any point can be risky. Historical trends suggest that successful stocks continue to perform well while underperforming stocks lag behind. However, exceptions do exist.
Paycom, a human capital management (HCM) software-as-a-service (SaaS) provider, exemplifies one such exception. The company’s stock is currently 70% below its peak. Despite this, Paycom’s revenue has nearly tripled since 2019, a year in which the company’s sales were approximately $600 million and the share price was around $170. Today, the share price remains unchanged, presenting a potentially rare valuation opportunity given the company’s robust free cash flow generation.
The primary driver behind Paycom’s declining share price is its slowing sales growth rate. This deceleration, according to management, is partly due to the introduction of the Beti payroll processing platform in late 2021. Beti allows employees to manage their own payroll, identifying and correcting errors before payroll processing, which reduces the need for reruns.
While this innovation is beneficial for customers, it has reduced Paycom’s revenue from payroll reruns, thus impacting sales growth. Nevertheless, investors with a long-term perspective may appreciate this trade-off as it enhances customer satisfaction. Paycom’s Net Promoter Score (NPS) of 67 significantly outperforms those of its peers Paychex, Workday, and ADP, reflecting strong customer approval.
Furthermore, recent indicators from Paycom’s second-quarter earnings call suggest that the slowdown in sales growth may be reversing. CEO Chad Richison reported a 24% increase in unit sales year-over-year for the second quarter and indicated a 40% increase in July starts from a revenue perspective, suggesting potential higher sales growth in the third quarter. Additionally, Beti’s launch in international markets like Canada, Mexico, the U.K., and Ireland could drive further growth.
Paycom continues to prioritize innovation and customer satisfaction by increasing its research and development (R&D) spending. Despite this, the company has maintained resilient free cash flow. Paycom has demonstrated its ability to develop new, valuable automated offerings like the GONE time-off requests tool, which provides significant savings for clients.
Currently, Paycom is trading at a historically low price-to-free cash flow ratio. With $346 million in cash and no long-term debt, the company is executing a $1.5 billion share buyback plan, which could positively impact the share price. Additionally, Paycom offers a 0.9% dividend, though it has not increased this dividend since its inception six quarters ago.
Given these factors, there is potential for Paycom’s sales growth to rebound in the coming years. This, combined with the company’s consistent profitability and innovation, makes it a compelling long-term investment at its current valuation.