Think ADP Stock Is Expensive? You Should Consider Paycom Stock
After gaining 30% in the past quarter, ADP stock (NASDAQ: ADP) looks fairly priced based on its current P/S multiple of 5x. However, the market is pricing ADP’s competitor Paycom Software (NYSE: PAYC) at a much higher P/S multiple of 30x. Does that make ADP a better buy over PAYC? Comparing a slew of factors such as historical revenue growth, returns, and risk, Trefis believes that Paycom Software stock has more room for growth despite its higher P/S multiple.
The price-to-sales or P/S multiple for a company is higher when the sales growth is higher, and it has a demonstrated ability to translate those sales to profits, with an expectation to do so consistently. In the past few years, Paycom’s revenues have grown at an annual rate of 31% and its operating margins have consistently remained within the 28-30% range. Interestingly, Paycom’s revenues are just a fraction of ADP’s (5% of ADP), but its market capitalization of $24 billion is about one-third that of ADP’s $72 billion. At 30% growth, Paycom’s Revenues can reach a quarter of ADP’s revenues in the next 5 years – indicating a strong likelihood of a downtrend in the stock for the market leader ADP. Our dashboard ADP vs. Paycom: Is ADP Stock Appropriately Valued Given Its lower P/S Multiple Compared to Paycom? details the fuller picture, parts of which are summarized below.
- Revenue Growth
Paycom Software’s revenue growth has been much stronger than ADP’s over the last three years, with Paycom’s Revenue expanding at an average rate of 31% per year from $329 million in 2016 to $737 million in 2019, versus ADP’s Revenue which grew by 6% per year from $12.4 billion in FY2017 to $14.6 billion in FY2019.
- Paycom’s growth is driven by the acquisition of new clients and expansion of its product offering from traditional Human Capital Management (HCM) to integrated cloud-based solutions. ADP, on the other hand, is the industry leader and handles 1 out of 6 payrolls in the U.S. Thus, ADP’s growth is dependent on macroeconomic factors such as GDP, employment statistics, wage growth, etc.
- Paycom’s client base increased by 50% from 17,800 in 2016 to 26,500 in 2019 supporting the strong revenue growth and earnings. In the recent earnings release, the company highlighted that it currently has a 5% market share and is in a good position to generate strong growth in the coming years.
- Returns (Profits)
Coming to Returns, ADP is the market leader in the payroll processing business and has been providing consistent returns to investors as dividends and share repurchases. ADP reports a lower operating margin mainly due to its PEO business, where employees of clients are co-employed by ADP.
- In 2020, ADP’s Employer Services and Professional Employer Organization reported a net margin of 30% and 12.5%, respectively. With a 70% share of total revenues, the Employer Services segment is the primary earnings contributor for ADP.
- Paycom sells human capital management software to organizations and generates a bulk of its revenues from payroll processing. Paycom’s product offerings can be fairly compared to ADP’s Employer Services segment, which provides technology-based human capital management services. Thus, Paycom’s 30% operating margin is comparable to ADP’s Employer Services segment margins.
- Consistent with high revenue growth, Paycom’s operating income has more than doubled from $101 million in 2016 to $226 million in 2019.
- Risk
As neither of the two companies has considerable debt on their balance sheet, market consolidation or technological disruption are the keys risks to their revenues and earnings.
- As the market leader, ADP serves 860,000 clients and processes one in six American payrolls.
- Betting on the industry leader will provide consistent returns as the topline is less volatile and depends on macroeconomic factors.
- With the topline being just a fraction of ADP, competitive rivalry can cause a sharper dip in Paycom’s revenues compared to ADP.
- However, Paycom has consistently grown by 30% (y-o-y) – highlighting the company’s edge over its competitors.
While Paycom Stock has been on a bull run and looks promising, 2020 has created many pricing discontinuities that can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Amazon vs. Etsy. Another example is Apple vs. Microsoft.
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