What a time it’s been for Paylocity. In the past six months alone, the company’s stock price has increased by a massive 41.8%, reaching $152.67 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in Paylocity, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Is Paylocity Not Exciting?
Despite the momentum, we’re cautious about Paylocity. Here are three reasons why there are better opportunities than PCTY, plus one stock we’d rather own.
1. Weak ARR Points to Soft Demand
While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.
Paylocity’s ARR came in at $415.6 million in Q2, and over the last four quarters, its year-on-year growth averaged 12.2%. This performance was underwhelming and suggests that increasing competition is causing challenges in securing longer-term commitments. 
2. Projected Revenue Growth Is Slim
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Paylocity’s revenue to rise by 6.7%, a deceleration versus its 22.7% annualized growth for the past five years. This projection doesn’t excite us and implies its products and services will face some demand challenges.
3. Operating Margin Rising, Profits Up
Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.
Analyzing the trend in its profitability, Paylocity’s operating margin rose by 2.7 percentage points over the last two years, as its sales growth gave it operating leverage. Its operating margin for the trailing 12 months was 21.8%.
Final Judgment
Paylocity’s business quality ultimately falls short of our standards. After the recent surge, the stock trades at 4.2× forward price-to-sales (or $152.67 per share). This valuation multiple is fair, but we don’t have much faith in the company. We’re pretty confident there are more exciting stocks to buy at the moment. We’d recommend looking at one of Charlie Munger’s all-time favorite businesses.
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