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My investing thesis for Paycom Software (NYSE:PAYC) is pretty simple. This provider of payroll and workforce management software has a long runway for growth ahead. Its products are highly valued by its customers. And its margins should continue to rise as Paycom’s business scales up. All of which should help power robust earnings growth in the years ahead.

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Even after a big run-up, there’s plenty of room to grow

The human capital management (HCM) industry is a crowded field full of large competitors like ADPPaychexOracle, and SAP. With a market cap of around $4.8 billion , Paycom is still a small fish in that big pond — which is getting larger every year. According to Markets and Markets, the global HCM market is expected to grow from $14.5 billion in 2017 to $22.5 billion by 2022.

A laptop, a tablet and a phone showing various Paycom software screens on an office desk

IMAGE SOURCE: PAYCOM SOFTWARE

Paycom’s growth over the last few years has been nothing short of impressive. From 2012 to 2016, Paycom’s revenue has increased at a compound annual growth rate of 44%. And while that number has cooled off a bit, in 2017, the company is guiding for another year of 30+% top-line growth.

Future growth will be driven by Paycom’s plans to increase its number of sales offices from 45 today to an ultimate goal of 120. With each office able to support around $6.15 million in annual sales, Paycom’s eventual annual sales capacity would be roughly $738 million — which would be incremental to the recurring revenue generated by existing clients. When you consider that the company’s full-year 2017 revenue guidance is $430.5 million at the midpoint, and that nearly all of that will be recurring revenue, Paycom’s growth potential remains enormous.

The scenario above might even dramatically understate Paycom’s long-term growth prospects. According to the company, roughly half of American workers are employed by businesses in Paycom’s target range of 50 to 2,000 employees. But on an annualized revenue per employee basis, CEO Chad Richison has stated that Paycom currently represents just 2% of the total addressable market for companies of that size. Richison has also said he believes the company could one day reach $1 billion in annual sales.

Keeping clients satisfied in a fiercely competitive industry

Paycom offers its clients an all-in-one HCM solution that runs on a single database in the cloud, eliminating the complexities, costs and headaches sometimes caused by cobbling together single-function solutions from multiple providers.

Paycom’s customers appear to see plenty of value in this solution, because over the last several years, the company’s retention rate — which measures the percentage of revenue retained from existing clients — has remained steady at 91%. That means Paycom’s “churn” is just 9% of its revenue base — which would include companies that go out of business, are acquired, or who leave Paycom for a competitor. That solid retention rate speaks volumes about Paycom’s customer satisfaction, and also demonstrates that its clients don’t tend to be susceptible to competitors offering lower prices.

More margin expansion ahead

As Paycom has scaled up, its margins have steadily increased. The company’s adjusted EBITDA margin — which measures operating profitability as a percentage of revenue — nearly doubled from 16.7% in 2012 to 28.7% in 2016. And even with Paycom investing heavily in R&D, marketing, and its sales team in order to maximize top-line growth in 2017, the company is on track to match the record margin level it achieved last year.

While the company will continue to spend aggressively to build its sales team, and R&D costs will likely keep growing at 80% to 100% each quarter (compared to the prior year), Paycom’s margins should continue to rise in the years ahead as these expenses get spread across an ever-increasing revenue base. In fact, management’s long-term target for adjusted EBITDA margin is a range of 30% and 33%.

Paycom’s combination of rapidly rising revenues, high levels of client satisfaction, and expanding margins ought to lead to significant earnings growth for the foreseeable future. The company is guiding for adjusted EBITDA growth of more than 30% in 2017, and I expect this serial compounder will be able to repeat this formula for many years to come.

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