Paycom Software Remains Undervalued

I last reviewed Paycom Software (PAYC) in my November 2, 2023 post following the release of Q3 and YTD2023 results. Despite reasonably good results, they fell short of the company's guidance range as a result of lower-than-expected service revenues and unscheduled payroll runs. Investors did not respond well and punished PAYC's share price.

Following the February 7 market close, PAYC released its Q4 and FY2023 results. With this information now available, I revisit this existing holding.

Business Overview

Refer to my November 2 post. In that post and my August 3, 2023 post, I touched upon Paycom’s Beti® (Better Employee Transaction Interface). This enhancement to the existing payroll offering further automates and streamlines the payroll process by empowering employees to do their own payroll, increasing efficiencies and reducing errors.

On the Q4 earnings call, Mr. Richison (founder and Co-CEO) stated:

Beti has been one of the products at the leading edge of our AI and automation strategy, delivering tremendous ROI to our clients. A recently commissioned third-party study on Beti highlighted 3 benefit areas. On average, a greater than 80% reduction in errors, a 90% reduction in time spent processing payroll and improved employee engagement. A leader within the restaurant industry noted that the automation from Beti took days off payroll processing time and that as employee checkers went down, employee engagement went up.

Additionally, certain organizations using Beti experienced up to 100% of their end users regularly engaging with our easy-to-use system.

In 2023, PAYC delivered a lot of innovation on the international front. It launched its global Human Capital Management (HCM) product. Companies of all sizes now use this product across 180 countries and in 15 languages and dialects.

It also developed and launched native payroll in Canada and Mexico and it is currently launching its native payroll solution in the United Kingdom.

This international strategy complements PAYC's product strategy and provides it with the opportunity to pursue opportunities with US-based companies that have an international presence.

Executive Changes

PAYC has strengthened its leadership team with the appointment of:

Details of PAYC's management team is accessible here.

These changes, and in particular the appointment of a Co-CEO, will allow the founder of PAYC to invest further in the areas of product innovation and strategy.


Q4 and FY2023 Results

The following reflects PAYC's FY2024 outlook when it reported its Q3 and YTD2023 results.

  • Q4 2023 total revenue of ~$0.42B - ~$0.425B, representing a growth rate over Q4 2022 of ~14% at the midpoint of the range;
  • Q4 adjusted EBITDA forecast of ~$0.169B - ~$0.174B, representing an adjusted EBITDA margin of 41% at the midpoint of the range;
  • FY2023 revenue of ~$1.679B - ~$1.684B or growth of ~22% YoY at the midpoint of the range; and
  • FY2023 adjusted EBITDA of ~$0.712B - ~$0.717B. This is an adjusted EBITDA margin of ~43% at the midpoint of the range.

PAYC's actual FY2023 results are:

  • Total revenue of ~$1.694B versus ~$1.375B in FY2022;
  • Adjusted EBITDA of ~$719.302 million versus ~$579.711 million in FY2022.
  • GAAP Net Income of ~$340.8 million, or $5.88/diluted share versus ~$281.4 million, or $4.84/diluted share, in FY2022.
  • Adjusted diluted non-GAAP Net Income of ~$449.485 million, or $7.75/diluted share after accounting for a ~$1.222 million loss on the extinguishment of debt and ~$129.806 million of non-cash stock-based compensation expenses, versus $6.14/diluted share in FY2022.

Revenue growth was driven by new business wins, partially offset by lower cross-selling to existing clients.

PAYC ended 2023 with ~36,800 clients, representing a growth rate of 1% compared to 2022. On a parent company grouping basis, it ended the year with ~19,500 clients, up 2% compared to 2022.

Client count for companies with greater than 500 employees was up 11% YoY and up ~18% YoY for companies with greater than 2,000 employees.

The total number of employee records stored in PAYC's system in 2023 was 6.8 million.

PAYC's annual revenue retention rate in 2023 was ~90% compared to ~91% in 2022 with attrition. This attrition was concentrated primarily at the low end of the market. PAYC's Q4 Earnings Release explains the change in the calculation of the 'Annual Revenue Retention Rate'.

Historically, we calculated annual revenue retention rate as total revenues minus revenue attrition, divided by total revenues. Revenue attrition is equal to the actual recurring fees paid by clients during the 12 months preceding the respective dates on which they last processed payroll with us. Throughout 2023, as we increased our engagement efforts with clients and our efforts to reduce attrition, it was important for us to identify revenue attrition more quickly. In July 2023, we implemented operational changes related to how we mobilize our services department to manage relationships with clients that have missed a payroll, as well as a contemporaneous change to our standard services agreement. These strategic operational and contractual changes accelerate the point at which a client is deemed “lost” for purposes of our annual revenue retention rate calculation. Further, we are now excluding interest earned on funds held for clients from the calculation, which has been immaterial to date. Based on the new methodology, the annual revenue retention rates for the years ended December 31, 2023, 2022 and 2021 were 90%, 91% and 94%, respectively, with losses concentrated primarily among smaller clients. These changes to the annual revenue  retention rate calculation had no impact on reported financial results. We believe these increased engagement efforts and operational changes contributed to an increase in the revenue retention rate in the month of January 2024 compared to the same period in the prior year.

PAYC continues to invest in the long-term future growth opportunities, including in areas of automation, AI and innovation. Adjusted R&D expense was $51 million in Q4 or 11.6% of total revenues. Adjusted total R&D costs, including the capitalized portion, were $73 million in Q4 2023 compared to $52 million in the Q4 2022.

On the CAPEX front, PAYC's 5th building in Oklahoma City is substantially complete.

Further details are reflected in PAYC's Q4 2023 Earnings Release.

Q1 and FY2024 Outlook

PAYC's Q1 outlook is:

  • Total Revenues of $0.494B - $0.497B or ~10% growth at the midpoint which is comparable to Q1 2023.
  • Adjusted EBITDA of $0.218B - $0.222B or ~44% at the midpoint of the range.

Its FY2024 outlook is:

  • Total Revenues of $1.860B - $1.885B or ~11% YoY growth at the midpoint which is consistent with the target growth range provided on the Q3 2023 earnings call.
  • Adjusted EBITDA of $0.720B - $0.730B or a margin of ~39% at the midpoint of the range.

The CAPEX as a percent of revenues forecast for FY2024 is ~12%. In FY2023, this was ~11.3%.

Operating cash Flow (OCF) and Free Cash Flow (FCF)

In FY2014 - FY2023, PAYC generated OCF of approximately (in millions of $) 22, 43, 99, 130, 185, 224, 227, 319, 365, and 485.

In FY2014 - FY2023, PAYC generated FCF of approximately (in millions of $) 8.07, 26.42, 55.01, 70.76, 124.91, 131.33, 133.11, 193.17, 228.31, and 292.

Credit Ratings

PAYC has no debt to be rated.

The $29 million in long-term debt outstanding at the end of Q3 2023 has been fully repaid. This balance was owed under PAYC's July 2022 Revolving Credit Agreement and was due July 29, 2027.

Even after the substantial buybacks and dividends distributions, PAYC ended FY2023 with a very strong balance sheet; it had ~$0.294B of cash and cash equivalents and $0 debt. Its Current Liabilities before client funds obligation were only ~$0.207B.

As noted in prior posts, the ~$0.023B in short term deferred revenue and the ~$0.108B in long-term deferred revenue represents funds received from clients in advance of providing services.

Dividends and Share Repurchases

Dividend and Dividend Yield

PAYC has a brief dividend history having distributed its first quarterly dividend on June 12, 2023.

On February 5, it declared its 4th consecutive $0.375/share quarterly dividend. Using my recent ~$192 purchase price, the dividend yield is under 1%.

I anticipate that PAYC will increase its quarterly dividend when it declares its next dividend in May. However, I expect the bulk of any future total investment return will be predominantly in the form of capital appreciation.

Share Repurchases

PAYC's weighted average shares outstanding in FY2014 - FY2022 are (in millions of shares) 52, 58, 59, 59, 59, 58, 58, 58, and 58.

In Q4, PAYC repurchased ~1.2 million shares or ~2% of outstanding shares for a total of $0.213B. In FY2023, it repurchased $286.618 million of its issued and outstanding shares. The weighted average diluted shares outstanding in FY2023 was 57.974 and 57.229 in Q4.

In May 2016, PAYC's Board authorized a stock repurchase plan allowing for the repurchase of shares of common stock in open market transactions at prevailing market prices, in privately negotiated transactions or by other means in accordance with federal securities laws.

Since the initial authorization of the stock repurchase plan, PAYC's Board has amended, extended and authorized new stock repurchase plans from time to time. Most recently, in August 2022, the Board authorized the repurchase of up to $1.1B of common stock.

As of December 31, 2023, PAYC has repurchased over 6.1 million shares and there remains ~$0.8B under its buyback authorization.


PAYC's FY2014 - FY2022 diluted PE levels are 117.59, 66.90, 75.78, 73.32, 92.90, 160.37, 140.74, and 72.17.

While the historical PE levels are high, this is a rapidly growing company. PAYC's FY2014 revenue (the year it went public) was $151 million. In FY2023, its revenue was ~$1.694B.

At the time of my November 2 post, PAYC had just reported $1.77 and $5.84 in Q3 and YTD2023 adjusted diluted EPS. Were it to generate $1.80 of adjusted diluted EPS in Q4, its FY2023 adjusted diluted EPS would be ~$7.64. Using the ~$150 share price when I wrote my post, the forward adjusted diluted PE was ~19.6.

The forward-adjusted diluted PE levels using current broker estimates and the current ~$150 share price were:

  • FY2023 - 20 brokers - ~19.7 using the mean of $7.62 and low/high of $7.32 - $7.75.
  • FY2024 - 20 brokers - ~18.1 using the mean of $8.27 and low/high of $7.57 - $9.53.
  • FY2025 - 13 brokers - ~15.3 using the mean of $9.82 and low/high of $8.48 - $11.80.

It generated ~$0.215B of FCF in the first 9 months of FY2023 and ~$0.169B in the first half of FY2023 with the difference being $46 million of FCF generated in Q3. If it were to generate $40 million of FCF in Q4, FY2023 FCF would be ~$0.255B. The weighted average diluted shares outstanding in Q3 were ~58 million thus giving us a FCF/share value of $4.40 and a P/FCF value of ~34 using a ~$150 share price.

We now know that PAYC generated $5.88 of GAAP EPS and $7.75 of adjusted diluted EPS. Using my recent ~$192 purchase price, the current diluted PE is ~32.7 and the current adjusted diluted PE is ~24.8.

In addition, we know that PAYC generated ~$292.450 million of FCF in FY2023. The weighted average shares outstanding in FY2023 were 57.974 million giving us a FCF/share of ~$5.04. Using my recent ~$192 purchase price, the current P/FCF is ~38. If we use the 57.229 weighted average shares outstanding in Q4 2023, we get a FCF/share of ~$5.11 and a current P/FCF of ~37.6.

PAYC's current forward-adjusted diluted PE levels using current broker estimates and my ~$192 purchase price are:

  • FY2024 - 21 brokers - ~24.5 using the mean of $7.83 and low/high of $6.82 - $8.48.
  • FY2025 - 19 brokers - ~21.6 using the mean of $8.89 and low/high of $7.94 - $9.6.
  • FY2026 - 5 brokers - ~18.3 using the mean of $10.49 and low/high of $10.03 - $10.87.

I envision these estimates will be adjusted very slightly over the coming days.

Final Thoughts

PAYC's topline growth during the FY2014 - FY2023 period (in billions of $) is $0.151, $0.225, $0.329, $0.433, $0.566, $0.738, $0.841. $1.056, $1.375, and $1.694. In addition, the company has no debt and international expansion should enable it to capture new customers.

At the time of my November 2 post, I considered shares to be very undervalued. I was, however, unable to take advantage of that buying opportunity.

The current valuation is not as attractive as in early November, but I think Paycom Software remains undervalued.

Lately, I have struggled to identify attractively valued investment opportunities. PAYC's current valuation, however, is appealing and on February 8, I acquired an additional 100 shares @ ~$192 in the 'Core' account within the FFJ Portfolio. This brings my PAYC exposure to 450 shares.

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long PAYC.

Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.