Enterprise-cloud technology and demand for it are accelerating in our increasingly digitalized world. Paylocity (PCTY - Free Report) is a cloud-based service that provides payroll and human capital management software solutions and has positioned itself to take shareholder returns to the clouds. Sell-side analysts are becoming increasingly optimistic about this company propelling it into a Zacks Rank #1 (Strong Buy).
PCTY has demonstrated insane share price appreciation so far in 2019, with shareholder returns of 77.5% in the past 8 months, trading just off its all-time highs.
Paylocity provides payroll and HCM software solutions to medium-sized US businesses, defined as businesses that employ anywhere from 20 to 999 individuals. The company currently services about 20,200 clients as of the end of June.
Paylocity has adopted the golden standard of cloud-based software-as-a-service (SaaS). Subscription-based services provide the company with a consistent and growing revenue stream that allows investors to be comfortable with excessively high multiples.
PCTY’s SaaS subscription-based software has been attracting an accelerating number of clients as its functionality progresses, and more medium-sized businesses find a competitive need to attain cloud-based HR software solutions. Without the infrastructure of a large corporation, it is more economical to use Paylocity’s cloud instead of investing in in-house infrastructure.
Paylocity has seen an accelerating client base that expanded 21% this past year with an over 92% retention rate. The company has been able to consistently grow its revenue per client through its broadening product offering that’s meeting more client needs.
This business has plenty of room to grow. There are over 638,000 medium-sized businesses in the US employing more than 45 million people according to Paylocity’s most recent 10-K, meaning that they have only penetrated 3% of their total accessible market (TAM). The company continues to advance its current portfolio of diversified products and services to attract a growing customer base.
PCTY is allowing smaller businesses to receive the same level of payroll and HCM support as a fortune 500 company through its diverse breadth of cloud-based platforms.
Competitors include ADP (ADP - Free Report) , Paychex Software (PAYX - Free Report) , and Paycom Software (PAYC - Free Report) . Paylocity’s competitive advantage lies in its cloud-based tech, a niche in medium-sized businesses, and its product offering breadth.
Valuation & Performance
Paylocity has been experiencing positive gains in all the right financial metrics illustrating a topline CAGR of 34% since the company went public 5 years ago. PCTY’s gross margins have ballooned from 49% in 2014 to 67%, illustrating productive economies of scale along with consistent profitability and free-cash-flow growth. The firm has a healthy balance sheet with a growing stockpile of cash and no debt.
Having no debt on the balance sheet can be considered a double-edged sword. The firm is at no risk of default being completely funded by equity and its own cash flows, but the argument could be made that they aren’t leveraging all available capital to expand their business. None the less the company’s financials appear to be quite healthy.
Paylocity just recently turned a profit, so the most useful valuation metric is going to be forward P/S. PCTY’s forward P/S is 9.6x, trading above both the broader software market and its 5-year median. This firm’s valuations have expanded as its businesses model progressively proves itself.
This valuation may be validated if PCTY can hit its 20%+ top and bottom-line estimates over the next 2 years.
Paylocity is a solid growth play for a well-diversified portfolio. There is a significant amount of growth potential in cloud technology, especially when it comes to enterprise software. Businesses are forced to become increasingly digitalized to compete in today’s economy.
Medium-sized firms have a need for the cloud-based platform that Paylocity offers now it is just a matter of discovering it. I see an enormous amount of long term growth potential for this medium-cap stock.
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