Is Paycom Stock Overvalued?

by Trefis Team
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[Updated 2021/08/13]

In recent filings, Paycom Software (NYSE: PAYC) reported 30% (y-o-y) revenue growth assisted by expanding client bases and demand for human capital management software. Notably, the stock’s market capitalization is one-third of ADP’s (NASDAQ: ADP) due to continued strong revenue growth and market share gains. Interestingly, the shares of all HCM solution companies including Paychex, Paycor, Workday, and ADP have benefited from investor optimism in recent months despite the pandemic’s continued impact on the travel & tourism industry. Considering the high current valuation multiple of market leaders, ADP and Paychex, Trefis believes that Paycom stock has reached its near-term potential. We highlight Paycom’s stock performance with its peers and broader markets in an interactive dashboard analysis, Paycom Software Stock Return.

[Updated 2021/01/20] – 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.

  1. 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.

  1. 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.
  1. 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.

Do ADP’s peers offer better gains? ADP Stock Comparison With Peers summarizes how ADP compares against peers on metrics that matter. You can find more such useful comparisons on Peer Comparisons.

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