3 Reasons to Sell PAYC and 1 Stock to Buy Instead

Shareholders of Paycom would probably like to forget the past six months even happened. The stock dropped 43.8% and now trades at $128.00. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.

Is there a buying opportunity in Paycom, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.

Why Is Paycom Not Exciting?

Despite the more favorable entry price, we're sitting this one out for now. Here are three reasons you should be careful with PAYC and a stock we'd rather own.

1. Weak Billings Point to Soft Demand

Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.

Paycom’s billings came in at $543.4 million in Q4, and over the last four quarters, its year-on-year growth averaged 8.5%. This performance was underwhelming and suggests that increasing competition is causing challenges in acquiring/retaining customers.

2. Projected Revenue Growth Is Slim

Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.

Over the next 12 months, sell-side analysts expect Paycom’s revenue to rise by 6.6%, a deceleration versus its 19.5% annualized growth for the past five years. This projection doesn't excite us and indicates its products and services will face some demand challenges.

3. Shrinking Operating Margin

Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.

Looking at the trend in its profitability, Paycom’s operating margin decreased by 6 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 27.6%.

Final Judgment

Paycom isn’t a terrible business, but it isn’t one of our picks. After the recent drawdown, the stock trades at 3.1× forward price-to-sales (or $128.00 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're fairly confident there are better investments elsewhere. We’d recommend looking at the Amazon and PayPal of Latin America.

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