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Watching Paycom



July 10, 2014 – Comments (0) | RELATED TICKERS: PAYC

Board: Pencils Palace

Author: TMFPencils

A recent IPO, despite making an underwhelming entrance to the stock market (which is of little consequence to patient investors), recently caught my eye. Paycom Software (NYSE: PAYC) -- which just went public in April 2014 -- provides cloud-based solutions for businesses to manage "the complete employment life cycle from recruitment to retirement." In other words, Paycom's solutions bundle payroll and HR tools into a single application. Per a recent press release from Paycom:

Paycom's unrivaled proprietary software frees HR and others from compiling payroll, time and labor management and HR management reports by generating them on their behalf. All reports then can be exported in any format the company requests, including Excel, CSV and PDF.

Here are five factors that caught my eye during my initial analysis of Paycom:

1. Leadership and employee culture

Chad Richison founded Paycom in 1998 before turning 30 years old, and Richison -- now 43 -- remains CEO today. Richison owns 11% (or 5.67 million) of all shares outstanding and hasn't sold a single share since Paycom's IPO in April.

I actually came across Paycom while looking through Glassdoor’s Best Places to Work rankings. Paycom was ranked the fifth best mid-sized company to work for in the U.S. in 2014 based on employee reviews on Glassdoor, a platform where employees anonymously rate their respective places of work. Paycom employees give the company a 4.1/5 rating as a whole, and Richison earns an 89% employee approval rating as CEO. 79% of Paycom employees would recommend the company to a friend.

2. Diverse base of clients (and high retention rates)

Paycom serves more than 10,000 clients in all 50 states. None of these clients compose of more than .05% of the company's overall revenue, meaning that Paycom's success (or lack thereof) is not hinged on any one client.

Even better, however, is Paycom's customer retention rate. Thanks to comprehensive service provided by the company through one-on-one assistance to each of its clients, Paycom enjoyed an average annual customer retention rate of 91% for the three years ended 2013. This is over the 81% retention rate of Insperity (NSP) and slightly below the 92% retention rate seen at Paylocity (PCTY).

3. Opportunities for future growth

Spending on corporate training increased 15% in 2013 to more than $70 billion and $130 billion worldwide. This is following a 12% increase in 2012 and a 10% increase in 2011. Paycom has benefited from these workplace trends in the corporate world with sales increasing an average annual rate of 27.05% over the past four years to $107.6 million in 2013.

As of 2013, 86% of Paycom's clients were businesses with 50-2,000 employees. The company is particularly focused on expanding its clientele to larger companies with more than 2,000 employees, which currently comprise a mere 4% of Paycom's client base.

Paycom presently has 30 sales offices in 20 states, with plans to open six to eight new offices over the next two years to support both current and new clients. To put it in other words: the company's best days of growth are likely still ahead.

4. Cash flow growth

In 2011 Paycom was free cash flow negative, meaning that expenditures totaled more than the business itself was producing. Since 2011 the company has expanded operating cash flow at an average pace of more than 37% annually to $23.72 million in 2013, helping Paycom produce $6.54 million in free cash flow in 2013. This is a noteworthy achievement for a high growth company and boosts my confidence in the financial performance (and future) of the business.

5. Strong margins expansion

In 2010 Paycom lost money by a small margin, essentially breaking even for the year. Since 2011, however, the company has expanded its profit margin from 2.5% to 7.2% in 2013. Growing margins helped Paycom expand earnings fivefold between 2011 and 2013.

Foolish bottom line

Paycom currently trades at a P/S of 6.2 and a P/E of 200 with a market cap of approximately $750 million. The stock doesn't appear "cheap" by traditional standards, but with a dynamic company culture and very involved founder/CEO -- not to mention impressive growth and improving financial performance in a growing field -- I am not writing off Paycom.

Still, this is a very competitive field (and an industry I am not especially familiar with) and there is further research to be done. Paylocity seems to be another business in this field with strong retention rates and employee ratings on Glassdoor -- I want to research that business and other competitors to hone in on if Paycom (or any of these businesses, for that matter) has any sustainable competitive advantage.

You can read the full article here:

More research to come...

David K 

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