This week’s report for Steady Compounding Insider Stocks members dives into an update on Paycom. Since my initial deep-dive in July 2024, the stock has climbed 58%. In this report, I analyze Paycom's latest third-quarter earnings, discuss whether the company is turning a corner, and share my updated views on its valuation after the recent run-up in share price.

Below, you’ll find a free preview of my Paycom research.

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Compound steadily,

Thomas

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Before diving into Paycom’s latest earnings, let’s recap the challenges that led the stock to trade at a forward PE multiple of just 17x when we first covered it in July. Here’s an excerpt from that report:

Beti: Short-Term Pain, Long-Term Gain

Beti (Better Employee Transaction Interface) is a significant factor in Paycom’s recent revenue growth slowdown. This new HR platform empowers employees to manage their payroll directly, reducing errors and minimizing HR intervention.

Traditionally, Paycom generated revenue from correcting payroll errors and running unscheduled payrolls. Beti’s efficiency in minimizing these issues has decreased such billable events. Essentially, Beti’s success in automating payroll tasks is cannibalizing some of Paycom’s traditional revenue streams.

However, Beti is ultimately a win-win: it’s good for employees (greater transparency), beneficial for HR (fewer errors), and positive for Paycom, as it strengthens customer loyalty and enhances the long-term stickiness of Paycom’s offerings.

In other words, while Beti’s efficiency may cause short-term revenue pain, it aligns with long-term value creation. This is precisely the type of short-term trade-off Wall Street often frowns upon—and where opportunity may lie for patient investors.

Navigating the Industry Slowdown

Beyond Beti’s short-term impact, Paycom also faces the challenge of slower client growth between 2022 and 2023. Despite management’s claims of a long runway, client growth has slowed, increasing by only 0.7% to 36,820 clients in 2023.

However, it’s important to note that this slowdown isn’t unique to Paycom. The entire cloud software industry has experienced a decline in new Annual Recurring Revenue (ARR) growth rate from Q3 2022 to Q3 2023, as shown in the Altimeter chart below.

Q3 2024: Positive Growth Despite Beti Headwinds

Third-quarter revenue grew by 11.2% to $452 million, signaling a reversal from Paycom’s revenue slowdown in recent quarters. Management also raised guidance, projecting fourth-quarter revenue of $477 to $484 million, marking a 10.6% year-over-year growth at the midpoint.

Source: Finchat (get a 15% discount using this link)

This positive momentum is supported by management’s commentary during the earnings call. CEO Chad Richison mentioned that September was the strongest sales month in Paycom’s history:

While Beti continues negatively impacting revenue from existing customers, strong new client acquisition drove the overall revenue growth. Management acknowledged that they prioritize Beti adoption even if it means short-term revenue headwinds. Richison explained:

This focus on customer success is paying off. Revenue growth was primarily driven by new client acquisitions, with Richison confirming that September’s record sales were largely from “new business, new logo adds.”

When analysts asked whether the Client Relations Representatives (CRR) were cross-selling to existing customers while driving Beti adoption, management responded that they prioritized delivering sufficient value before promoting additional products:

Key Drivers of Client Growth

There are likely three reasons for the strong customer growth:

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Other Financial Highlights

Gross Margin: Declined by 258 basis points to 80.5% due to a new building investment and increased client service hiring.

Adjusted EBITDA: Increased 3.4% year-over-year to $171 million, representing a 38% margin, as Paycom ramps up AI and international expansion investments. Richison reiterated the company’s commitment to innovation:

“We’ve doubled down on innovation to include full automation. The software used in our industry will look different in a couple of years, and we’re the ones who are building it.”

Cash Position & Buybacks: With $326 million in cash and no debt, Paycom repurchased 300,000 shares for $44 million, or nearly 4% of shares outstanding, though it still has $1.5 billion remaining in authorization. Given the company’s strong cash position and robust free cash flow, a more aggressive share repurchase program at current valuations could benefit shareholders.

The company doesn’t report client count and retention rate quarterly, so we’ll need to wait for Q4 for these updates. However, based on management’s commentary, September appears to have been a strong month for new customer growth. Hopefully, Paycom will continue to carry this momentum through the end of the year.

So, where does Paycom go from here?

While revenue growth from existing customers will likely remain subdued as Paycom drives operational efficiencies for its clients, effectively “cannibalizing” some of its traditional revenue through automation, this strategy lays the groundwork for long-term success.

This approach increases the gap between the value provided to customers and the price they pay, which can ultimately strengthen Paycom’s customer relationships and platform loyalty. Although management hasn’t indicated if they’ll adjust pricing to capture this added value, focusing on increasing value is a wise first step for building long-term pricing power.

Although management has not indicated any plans to modify their pricing model to capture this increased value, it’s likely a matter of time.

The SaaS industry as a whole may soon face a similar pricing adjustment. Historically, SaaS companies have charged per user, but AI’s potential creates higher productivity with fewer users. This shift could create a substantial price-to-value gap, pushing SaaS providers to modify their pricing models to capture better the value delivered.

Currently, Paycom is focused on maximizing the value side of the equation. They are actively driving Beti utilization through their CRR team and investing heavily in R&D to introduce new automation features.

Meanwhile, it’s profitably growing revenue through new client acquisition, maintaining a solid 38% adjusted EBITDA margin. However, the real potential for accelerated growth lies in monetizing the increased value delivered to existing customers. This “second engine” of growth will be crucial for Paycom to achieve the revenue expansion it has historically delivered.

In the short term, I’ll be watching two key indicators:

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Valuations

While Paycom isn’t trading at the deeply discounted forward PE of 17x when we first covered Paycom in the deep-dive here, it’s also far from its median of 52x.

That said, any investing thesis that relies on an investment trading at a sky-high 50x PE multiple is usually a recipe for disappointment. Sustaining such valuations typically requires exceptional, continuous growth of over 20% over a prolonged period to get investors this excited unless you have a “Costco Halo.”

Regarding valuations, I’d rather take a reasonably conservative approach and let the surprises be on the upside. Sure, that may mean occasionally missing out on high-flyers that constantly smash expectations, but that’s no tragedy. There are plenty of solid, less flashy opportunities in the market that offer attractive returns without making me wince at their valuations.

Source: Finchat (get a 15% discount using this link)

Where does that leave us with Paycom?

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Join Steady Compounding Insider Stocks to access the full report and find out if Paycom is truly on the verge of a successful turnaround.

See you inside,

Thomas

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