Paycom Software Inc. (NYSE:PAYC)

The period under review demonstrates a shifting financial performance as measured by economic profit. Initially positive, economic profit transitioned to negative values over the observed timeframe. Net operating profit after taxes exhibited growth between 2018 and 2019, followed by a decrease in 2020, and then resumed growth through 2022. However, this growth in NOPAT was insufficient to offset the increasing invested capital and a relatively stable cost of capital, ultimately leading to declining economic profit.

Net Operating Profit After Taxes (NOPAT)

NOPAT increased from US$172.096 million in 2018 to US$214.806 million in 2019, representing a growth of approximately 24.8%. A subsequent decline to US$176.158 million occurred in 2020, before recovering to US$244.272 million in 2021 and further increasing to US$297.371 million in 2022. This indicates a volatile, but ultimately positive, trend in operational profitability.

Cost of Capital

The cost of capital remained remarkably stable throughout the period, fluctuating between 21.79% and 21.87%. This consistency suggests a stable risk profile and capital structure for the entity. The slight decrease in 2022 to 21.84% is minimal and unlikely to have a significant impact on economic profit calculations.

Invested Capital

Invested capital experienced substantial and consistent growth throughout the period. It increased from US$522.609 million in 2018 to US$724.133 million in 2019, US$860.024 million in 2020, US$1,189.369 million in 2021, and finally to US$1,478.485 million in 2022. This rapid expansion in invested capital is a key driver of the observed changes in economic profit.

Economic Profit

Economic profit began at US$58.201 million in 2018 and US$56.569 million in 2019, indicating the entity generated returns exceeding its cost of capital. However, economic profit turned negative in 2020 at US$-11.920 million, and continued to decline, reaching US$-15.688 million in 2021 and US$-25.579 million in 2022. This downward trend suggests that the returns generated by the invested capital are no longer sufficient to cover the cost of that capital, despite the growth in NOPAT.

The increasing invested capital, coupled with a stable cost of capital, appears to be the primary factor driving the decline in economic profit. While NOPAT has shown growth overall, it has not kept pace with the expansion of the capital base, resulting in diminishing returns on investment.

The financial data reveals notable fluctuations and overall growth in key profitability metrics over the five-year period ending December 31, 2022.

Net Income

Net income exhibited an upward trend, increasing significantly from $137,065 thousand in 2018 to $281,389 thousand in 2022. Despite a dip in 2020, when net income fell to $143,453 thousand from $180,576 thousand in 2019, the subsequent years showed robust recovery and growth, particularly with a substantial rise in 2022 to a new high.

Net Operating Profit After Taxes (NOPAT)

NOPAT followed a similar trajectory to net income but on a generally higher scale. It rose from $172,096 thousand in 2018 to $297,371 thousand in 2022. Although there was a decline in 2020, dropping to $176,158 thousand from $214,806 thousand in 2019, the profit metric rebounded strongly in the following years, reaching the peak in 2022. The increases in NOPAT were more pronounced in magnitude compared to net income, indicating increasing operational efficiency or improved core business profitability.

Overall, the data suggests a company experiencing notable profit growth, with a momentary setback in 2020 likely due to specific operational or market challenges during that year. The recovery and growth in NOPAT and net income in 2021 and 2022 demonstrate improved performance and potentially effective strategic or operational adjustments.

Provision for income taxes

The provision for income taxes showed a general increasing trend from 2018 to 2022. Starting at 37,646 thousand USD in 2018, it increased moderately to 45,511 thousand USD in 2019, then slightly declined to 42,483 thousand USD in 2020. Following this, there was a significant increase to 60,002 thousand USD in 2021, which was further amplified by a substantial rise to 108,189 thousand USD in 2022. This pattern indicates growing income tax obligations over the five-year period, with the most notable escalation occurring in the last two years.

Cash operating taxes

Cash operating taxes also exhibited an overall upward trajectory throughout the years analyzed. Initially, it stood at 16,816 thousand USD in 2018 and increased sharply to 24,932 thousand USD in 2019. There was a slight dip in 2020 to 21,299 thousand USD, followed by a recovery to 27,310 thousand USD in 2021. The year 2022 saw a dramatic increase to 112,250 thousand USD, which mirrors the substantial rise observed in the provision for income taxes. This suggests that cash outflows related to operating taxes have grown significantly, particularly in the most recent year.

Total Reported Debt & Leases

The total reported debt and leases exhibited a relatively stable trend from 2018 through 2021, decreasing slightly from 61,588 thousand USD in 2018 to 58,790 thousand USD in 2020, followed by a marginal increase to 60,067 thousand USD in 2021. In 2022, however, there was a noticeable increase to 70,012 thousand USD, marking a significant rise compared to previous years.

Stockholders’ Equity

Stockholders’ equity demonstrated a strong upward progression over the five-year period. Beginning at 334,753 thousand USD in 2018, equity more than doubled to 526,628 thousand USD in 2019 and continued to climb to 655,643 thousand USD in 2020. The growth accelerated thereafter, reaching 893,714 thousand USD in 2021 and further increasing to 1,182,607 thousand USD in 2022. This consistent increase indicates substantial equity growth and strengthening of the company’s financial position.

Invested Capital

Invested capital showed a continuous and significant rise throughout the entire period. Starting at 522,609 thousand USD in 2018, the invested capital increased by approximately 38.6% to 724,133 thousand USD in 2019 and then continued to expand sharply to 860,024 thousand USD in 2020. The momentum persisted with a considerable jump to 1,189,369 thousand USD in 2021, followed by another substantial increase to 1,478,485 thousand USD in 2022. This trend reflects ongoing investment and expansion activities within the company.

The economic spread ratio exhibited a consistent decline over the observed period. Initially positive, the ratio transitioned to negative values, indicating a diminishing ability to generate returns exceeding the cost of capital.

Economic Spread Ratio

In 2018, the economic spread ratio stood at 11.14%, representing a substantial margin between returns and the cost of capital. This ratio decreased to 7.81% in 2019, suggesting a narrowing of this margin. A significant shift occurred in 2020, with the ratio becoming negative at -1.39%, and this trend continued with further declines to -1.32% in 2021 and -1.73% in 2022. The consistent negative values from 2020 onwards indicate that returns generated were less than the cost of invested capital.

The trend in economic profit mirrors the decline in the economic spread ratio. While positive in 2018 and 2019, economic profit became negative in 2020 and continued to decrease in absolute value through 2022. This suggests that the decreasing spread ratio directly contributed to the erosion of economic profit.

Invested Capital

Invested capital consistently increased throughout the period, rising from US$522,609 thousand in 2018 to US$1,478,485 thousand in 2022. This growth in invested capital occurred concurrently with the decline in the economic spread ratio and the shift to negative economic profit. The increasing capital base, coupled with diminishing returns, likely exacerbated the negative trend in economic performance.

The combination of a declining economic spread ratio and increasing invested capital suggests a potential issue with capital allocation efficiency. Despite deploying more capital, the company’s ability to generate returns above its cost of capital diminished over time.

The economic profit margin exhibited a clear downward trajectory over the observed five-year period. Initially positive, the margin transitioned to negative values, with the magnitude of the negative result increasing each year.

Economic Profit Margin

In 2018, the economic profit margin stood at 10.05%. This represents the percentage of each revenue dollar remaining as economic profit after accounting for the cost of capital. A subsequent decline was observed in 2019, with the margin decreasing to 7.55%.

The trend reversed significantly in 2020, as the economic profit margin fell to -1.40%, indicating that the company’s returns were not sufficient to cover its cost of capital. This negative trend continued and intensified in 2021, with the margin reaching -1.47%.

By 2022, the economic profit margin had further deteriorated to -1.84%. This represents the largest negative margin observed during the period, suggesting a widening gap between the company’s returns and its cost of capital.

The decline in economic profit margin correlates with changes in economic profit and adjusted revenues. While adjusted revenues consistently increased throughout the period, economic profit decreased from positive values in 2018 and 2019 to negative values from 2020 onward. This suggests that revenue growth alone was insufficient to maintain profitability relative to the company’s cost of capital.

The consistent decrease in the economic profit margin warrants further investigation into the factors driving the increasing cost of capital or decreasing returns on investment. The trend suggests a potential erosion of shareholder value if not addressed.