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Paycom Software: A Promising Tech Stock with Growth Potential

Paycom Software provides cloud-based human capital management (HCM) solutions as a software-as-a-service (SaaS). HCM is critical for companies, making Paycom Software's products highly "sticky." As a result, Paycom Software enjoys a high retention rate, and nearly all of its revenue is recurring. These features—sticky products, high retention rates, and recurring revenue—are indicators of a potentially good investment opportunity. In this analysis, I will investigate whether it is the right time to invest in Paycom Software.

This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in Paycom Software. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro, You can find instructions on how to do this here. I don't own any stocks in competitors of Paycom Software either. Thus, I have no personal stake in Paycom Software. If you want to purchase shares (or fractional shares) of Paycom Software, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started with investing with as little as $100.

Paycom Software is a leading provider of a comprehensive, cloud-based human capital management (HCM) solution delivered as Software-as-a-Service (SaaS). Founded in 1998 and based in Oklahoma, United States, the company offers the functionality and data analytics that businesses need to manage the complete employment lifecycle, from recruitment to retirement. Paycom Software's solution requires virtually no customization and is based on a core system of record maintained in a single database for all HCM functions, including talent acquisition, time and labor management, payroll, talent management, and human resources (HR) management applications. The user-friendly software allows for easy adoption by employees, enabling them to self-manage their HCM activities in the cloud, which reduces the administrative burden on employers and increases employee productivity. Paycom Software serves a diverse client base in terms of size and industry, with approximately 36.800 clients. Notably, none of these clients contribute more than one-half of one percent of their revenues. In 2023, Paycom Software achieved a retention rate of 90%, with 98% of its revenue being recurring. The company believes that its unique value proposition distinguishes it from other market offerings that require complex integrations and manual entry activities. This value proposition, combined with a high retention rate and strong reputation, provides Paycom Software with a significant competitive advantage. The company has been named one of the most trustworthy companies in America by Newsweek for the third consecutive year, further solidifying its moat.

The CEO of Paycom Software is Chad Richison. Chad Richison has been the CEO of Paycom Software since he founded the company in 1998. He also serves as President and Chairman of the Board, and is the largest shareholder, owning approximately 12% of the shares. Chad Richison began his career in sales with a national payroll and human resources company and a regional payroll company before founding Paycom. He holds a bachelor’s degree in mass communications-journalism from the University of Central Oklahoma. In 2024, Chad Richison faced some controversy when a recording of one of his employee meetings was secretly recorded and widely perceived as a rant, which did not reflect well on him. Additionally, he appointed Chris Thomas as co-CEO, who left the company a few months later due to personal reasons. Despite these issues, Paycom Software earned the Gallup Exceptional Workplace Award for the second consecutive year in 2023, indicating a positive workplace culture under Chad Richison's leadership. Furthermore, Chad Richison has an employee rating of 87/100 on Comparably, placing him in the top 5% of CEOs of similarly sized companies. I personally appreciate when a CEO is also the founder and largest shareholder, as they typically align their interests with those of the shareholders. It is also impressive that Chad Richison has grown Paycom Software from its inception to being part of the S&P 500. Despite the controversies in 2024, I believe Chad Richison remains the right person to lead Paycom Software moving forward.

I believe that Paycom Software has a moat. I also like the management despite the recent controversy. Let's now analyze the financials to evaluate if Paycom Software meets our criteria for a strong competitive advantage. For further clarification on the financial metrics, please refer to "MY STRATEGY" on the website.

The first metric I investigate is the return on invested capital (ROIC). Ideally, we want to see 10 years of historical data, with numbers exceeding 10% across all benchmarks. Paycom Software has consistently delivered a ROIC above 10% in all years except for 2014. Given that Paycom Software went public in April 2014, the figures from that year are less significant. It is noteworthy that Paycom Software has achieved a ROIC above 15% in all years except for 2014 and has maintained a ROIC above 20% every year since 2016. Although ROIC has not reached the pre-pandemic heights, maintaining over 20% during the pandemic and the challenging years that followed is impressive. Furthermore, it is encouraging to see that Paycom Software delivered its highest post-pandemic ROIC in 2023. Overall, these numbers are impressive and demonstrate that Paycom Software is a high-quality company.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the percentage growth year over year. Paycom Software is a textbook example of how a company should increase its equity. Although we lack data from 2013 due to Paycom Software's IPO in 2014, the company has demonstrated consistent equity growth from 2014 to 2023. Not only has the equity increased every year, but it has also done so by more than 10% annually. These numbers are particularly impressive and highlight Paycom Software's robust financial health and effective growth strategy.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising that Paycom Software has delivered positive free cash flow every year since its IPO, a feat that few companies manage to achieve. Additionally, Paycom Software has consistently grown its free cash flow each year since going public, which is particularly impressive. The free cash flow margin has remained consistently high over the years. Although the levered free cash flow margin has not reached its previous heights, it is encouraging to see an increase from 2022 to 2023. The free cash flow yield has historically been low, indicating that Paycom Software has been trading at a premium. However, it is currently at its highest level since the IPO, suggesting that the company may now be trading at more attractive valuations. This is an aspect we will revisit later in the analysis.

Another important aspect to investigate is the level of debt, specifically whether a business has manageable debt that can be paid off within a period of three years. This is assessed by dividing the total long-term debt by earnings. Upon calculating this ratio for Paycom Software, it is evident that the company has no debt. This is a significant advantage and further enhances the attractiveness of Paycom Software as an investment opportunity.

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Based on my findings so far, Paycom Software appears to be a very intriguing investment. However, all investments come with risks, and Paycom Software is no exception. One significant risk is competition. The market for human capital management (HCM) software is highly competitive, rapidly evolving, and fragmented. If Paycom Software is unable to compete effectively, its business, operating results, or financial condition could be adversely affected. Paycom Software has indicated that they expect competition to continue intensifying as new technologies and market entrants emerge, and aggressive pricing strategies persist. The company's competitors range from small, regional firms to large, well-established international firms with multiple product offerings. Many competitors now offer cloud-based solutions, resulting in increased competition for clients seeking the flexibility and accessibility provided by cloud-based offerings. Additionally, the HCM industry has seen the rise of white label and embedded payroll offerings, further increasing competitive pressure. Paycom Software has noted that competition varies depending on the size of the customers. For small businesses, price tends to be the most important factor, whereas the scope of features and customization are more critical for larger businesses. Consequently, Paycom Software needs to compete on both price and the scope and customization of its offerings. Another significant risk for Paycom Software is government regulations. The company operates in a highly regulated industry, making its business subject to a wide range of complex U.S. and international laws and regulations. Changes in employment laws, tax codes, or other regulations can impact Paycom Software's operations. Failure to comply with these laws and regulations could lead to substantial costs or result in the suspension or revocation of licenses or registrations. Other potential consequences include the limitation, suspension, or termination of services, the imposition of consent orders, civil and criminal penalties (including fines), and lawsuits, including class actions. These outcomes could damage Paycom Software's reputation and have a materially adverse effect on its operational results or financial condition. Data security is another significant risk for Paycom Software. The company's solution involves the collection, storage, and transmission of confidential and proprietary information belonging to clients, their employees, and potential employees. This includes personal identifying information, as well as financial and payroll data. Human capital management (HCM) software is often targeted in cyber-attacks, including computer viruses, phishing attacks, malicious software programs, and other information security breaches. These attacks could result in unauthorized access to, release, gathering, monitoring, misuse, loss, or destruction of Paycom Software's or their clients’ sensitive data. To provide its services, certain employees of Paycom Software have access to sensitive information about their clients’ employees. Although Paycom Software conducts background checks on its employees and limits access to systems and data, it is possible that one or more individuals could circumvent these controls, resulting in a security breach. If Paycom Software's security measures are breached, or if unauthorized access to their clients’ sensitive data occurs, their solution may not be perceived as secure. Clients may reduce their use of or stop using the solution altogether, harming Paycom Software's ability to attract new clients. Additionally, the company could incur significant liabilities as a result of such breaches.

There are several compelling reasons to invest in Paycom Software. One key reason is its innovative payroll program, Beti. Beti is the first tool in the industry that empowers employees to handle their own payroll. It automatically identifies potential errors and guides employees to correct them before payroll submission. This process enhances the accuracy of paychecks, reducing costly corrections and allowing HR to focus on their core responsibilities. An independent study conducted by Forrester Consulting confirmed the value proposition of Beti, demonstrating how organizations can save millions of dollars by using Paycom Software's Beti solution. Specifically, the study showed that clients using Beti reduced the time spent correcting payroll errors by 85% and decreased labor for payroll processing by 90%. Furthermore, by automating tedious, time-consuming tasks, Beti enables HR professionals to focus on people rather than fixing preventable problems. Management has emphasized that Beti offers tremendous ROI for its clients. They anticipate continued interest in Beti as it leverages AI and decision-making logic across Paycom Software's solutions, adding more value and eliminating mundane, non-revenue-generating activities for clients. Feedback from clients indicates that their companies run much smoother when employees use Beti for payroll, a sentiment shared widely among Beti users. Management believes they are fundamentally changing the way payroll is managed, and client feedback supports this belief. Another reason to invest in Paycom Software is its time-off requests tool, GONE. GONE automates the time-off request process, allowing organizations to set a variety of decision-making criteria to ensure seamless business operations. Once configured, the software handles the rest, with automated decisions flowing accurately into payroll. Although it may not seem significant, clients currently make between 20 and 30 decisions per year per employee regarding paid time off, vacation requests, and the approvals or denials involved in staffing decisions. GONE eliminates these unnecessary interaction points by providing a consistent and fully automated experience for employees, managers, HR administrators, and the business as a whole. With GONE, employees in any industry can request time off at any time, such as midnight on a Friday, and receive immediate approval or denial. This is because GONE has automated all time-off request decisions. As a result, GONE enhances the employee experience and delivers both time savings and efficiencies for workforce management and scheduling. Launched in late 2023, GONE has already achieved considerable success. Management has indicated that the product offers great ROI for its clients. International expansion is another compelling reason to invest in Paycom Software. The company has recently extended its operations beyond the United States, launching native payroll services in Mexico and Canada in 2023, followed by the United Kingdom and Ireland in early 2024. Although Paycom Software's international expansion is still in its early stages, management has expressed excitement about the potential long-term impact of this strategy. Management has noted that US-based companies with an international presence are already considering Paycom as a global provider. This is exemplified by their recent acquisition of a large international sports organization as a client, attracted by Paycom's multi-country payroll and HCM offering. Paycom Software plans to focus its expansion on regions where its US-based clients have the largest number of employees, which is expected to include around 20 countries in total. This strategic international expansion could serve as a significant growth catalyst for Paycom Software in the future, further enhancing its market position and revenue potential.

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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.

The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 5,88, which is from the year 2023. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 15,5% in the next five years. Additionally, I have selected a projected future P/E ratio of 30, which is double the growth rate. This decision is based on Paycom Software's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $176,40. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Paycom Software at a price of $88,20 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 485, and capital expenditures were 193. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 135 in our calculations. The tax provision was 132. We have 57,701 outstanding shares. Hence, the calculation will be as follows: (485– 135 + 132) / 57,701 x 10 = $83,52 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Paycom Software's free cash flow per share at $5,07 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $80,03.

I believe that Paycom Software is an intriguing company due to its sticky product, high retention rate, and predominantly recurring revenue. Although there has been some recent controversy surrounding the CEO, his high employee rating and significant accomplishments—transforming the company from its inception to becoming part of the S&P 500—underscore his effective leadership. Paycom Software has delivered impressive numbers since its IPO, consistently maintaining a high return on invested capital (ROIC) and growing free cash flow annually. While competition poses a risk, with some competitors growing at a faster rate, I believe that Paycom Software's moat will protect it from future competitive threats. Government regulations present another risk, but Paycom Software has a strong track record of compliance, which is likely to continue. Data security is a major concern, as a breach could significantly impact the business by causing current customers to switch providers and making it more difficult to attract new clients. Although there is no indication that Paycom Software will experience a security breach, it is a risk that must be closely monitored. Paycom Software has high expectations for Beti, which offers tremendous ROI for its clients. While Beti is relatively new and there have been concerns about it cannibalizing other products, I believe that launching an improved program will be beneficial in the long term. GONE, though a smaller program, demonstrates Paycom Software's continuous innovation in developing new solutions to enhance client ROI, thereby increasing the stickiness of its offerings. The company has also recently begun its international expansion, with management expressing optimism about its future potential. This expansion could serve as a long-term growth catalyst for Paycom Software by increasing its total addressable market. There are many aspects to like about Paycom Software, and I am committed to buying shares below $120, which provides at least a 20% discount to intrinsic value based on all my calculations. In fact, I may consider purchasing shares at a higher price due to my strong belief in the business's potential.

My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how I do it, and how you can do it yourself, you can read this post.

I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.

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