Paycom Software stock (NYSE: PAYC) is up 16% since the beginning of this year, but at the current price around $308 per share, we believe Paycom stock has a significant downside.
Why is that? Our belief stems from the fact that Paycom’s stock has risen almost 4x from the low seen in early 2018. Our dashboard What Factors Drove 280% Change In Paycom Software Stock Between 2017 And Now? provides the key numbers behind our thinking, and we explain more below.
The rise over the past 2 years is justified by the 70% growth seen in Paycom’s revenues, which translated into a 46% growth in Net Income. With the outstanding share count roughly unchanged, earnings per share has risen 47% between 2017 and 2019.
Additionally, Paycom’s P/E ratio rose from about 38x at the end of 2017 to 84x at the end of 2019. While Paycom’s P/E has risen to 98x now, given the volatility of the current situation, there is possible downside for Paycom’s multiple when compared to levels seen in the past years – P/E of 52x at the end of 2018, and 84x as recently as 2019.
So what’s the likely trigger and timing to this downside?
The global spread of Coronavirus, and the resulting lock downs and quarantine means that a lot of businesses are struggling, and many will want to cut costs drastically. This is great news for Paycom as it is the only company providing fully online HR and payroll processing services, and is thus able to offer its services at a lower cost than its competitors. This advantage showed in Paycom’s Q2 results in August, where revenue came in at $181 million compared to $169 million for the same period last year. However, Paycom themselves are struggling to maintain their net margins amidst rising operating costs. Net income for Q2 came in at $28.5 million vs $49 million for the same period last year, despite a tax benefit of $1.8 million this quarter compared to $3.6 million in taxes paid in Q2 2019. We expect these rising costs to persist over the next few quarters, leading to 2020 EPS coming in much lower than the $3.14 in 2019. We believe Paycom’s Q3 results in October will confirm this and will also likely accompany a lower 2020 guidance.
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Regardless, if there isn’t clear evidence of containment of the virus anytime soon, we believe the stock will see its P/E decline from the current level of 98x to around 84x, which combined with a slight reduction in revenues and margins could result in the stock price shrinking to as low as $260.
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