Is Paycom Stock A Good Pick To Realize Long-Term Gains?

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The shares of Paycom Software (NYSE: PAYC) and Automatic Data Processing (NASDAQ: ADP) have been observing a downtrend in recent months fairly in-line with broader markets. Both companies offer human capital management services such as payroll processing, tax administration, time & labor management, etc. Interestingly, Paycom stock’s current P/S multiple is at historical lows as observed in April 2020 – indicating a likelihood of strong gains as macroeconomic risks associated with surging oil prices ease. Moreover, investors remain optimistic on ADP, highlighting an overall strength in the HCM industry. Comparing a slew of factors such as historical revenue growth, returns, and risk, Trefis believes that Paycom Software has substantial room for growth in the long run. Our dashboard Automatic Data Processing vs. Paycom Software: Sector Peers, But Paycom Software Is A Better Bet details the fuller picture, parts of which are summarized below.

  1. Revenue Growth

Paycom Software’s growth has been much stronger than ADP’s in the past three years, with Paycom’s revenues expanding at an average rate of 23.1% per year from $566.3 million in 2018 to $1.05 billion in 2021, versus ADP’s revenues which observed a 4% annual growth rate from $13.3 billion in FY2018 to $15 billion in FY2021.

  • ADP is the industry leader in payroll processing business with almost a 16% market share in the U.S. Thus, its business growth depends on macroeconomic factors such as GDP, employment statistics, wages, etc.
  • ADP categorizes its services into two parts, Management Solution (Employer Services) and Professional Employer Organization. Management Solutions segment provides key human capital management services including payroll processing, tax administration, HR solutions, and retirement services. The PEO (professional employer organization) is a comprehensive employment administration solution where employees working for a client are co-employed by ADP and the client (known as worksite employees).
  • Paycom offers cloud-based human capital management solutions including key services such as payroll management, time & labor management, data analytics, business intelligence, etc.
  • Paycom’s strong revenue growth has largely been driven by its rising client base, which has almost doubled from 17,800 in 2016 to 33,900 in 2021. (related: Workday Stock Is A Good Pick To Realize Gains)
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  1. Returns (Profits)

While both companies have been reporting a comparable net margin in recent years, Paycom has a significantly higher operating cash flow margin than ADP.

  • In 2021, ADP’s Employer Services and Professional Employer Organization reported pre-tax margin of 30% and 15%, respectively. With a 70% share of total revenues, Employer Services segment is ADP’s primary earnings contributor.
  • Paycom’s generates the bulk of its revenues from payroll processing services, which can be compared to ADP’s Employer Services segment. Thus, Paycom’s operating margin is comparable to ADP’s Employer Services segment margins.
  • In 2021, ADP and Paycom reported a net margin of 17% and 19%, respectively. However, Paycom’s operating cash flow margin stood much higher at 30% as compared to 21% for ADP.
  • Moreover, Paycom re-invests a considerable share of its operating cash largely due to strong revenue expansion whereas ADP is more focused on returning cash to investors as dividends and buybacks.
  1. Risk

As neither of the two companies have a considerable debt on their balance sheet, broader macroeconomic weakness and competitive rivalry are key risks to their businesses.

  • As a market leader, ADP processes one in six American payrolls.
  • Betting on the industry leader will provide consistent returns as the top line is less volatile and depends on macroeconomic factors.
  • However, Paycom’s consistent annual growth of more than 20% highlights its edge over the competitors.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio that’s beaten the market consistently since the end of 2016.

Returns Mar 2022
MTD [1]
2022
YTD [1]
2017-22
Total [2]
ADP Return 2% -15% 103%
PAYC Return -11% -27% 562%
S&P 500 Return -4% -12% 88%
Trefis MS Portfolio Return -5% -15% 236%

[1] Month-to-date and year-to-date as of 3/8/2022
[2] Cumulative total returns since the end of 2016

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