Are Paycom Software, Inc.’s (NYSE:PAYC) High Returns Really That Great?

Today we are going to look at Paycom Software, Inc. (NYSE:PAYC) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Paycom Software:

0.32 = US$185m ÷ (US$2.1b – US$1.5b) (Based on the trailing twelve months to March 2019.)

So, Paycom Software has an ROCE of 32%.

See our latest analysis for Paycom Software

Does Paycom Software Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Paycom Software’s ROCE is meaningfully better than the 9.6% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Paycom Software’s ROCE is currently very good.

NYSE:PAYC Past Revenue and Net Income, July 31st 2019
NYSE:PAYC Past Revenue and Net Income, July 31st 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Paycom Software.

What Are Current Liabilities, And How Do They Affect Paycom Software’s ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Paycom Software has total assets of US$2.1b and current liabilities of US$1.5b. Therefore its current liabilities are equivalent to approximately 72% of its total assets. While a high level of current liabilities boosts its ROCE, Paycom Software’s returns are still very good.

What We Can Learn From Paycom Software’s ROCE

In my book, this business could be worthy of further research. Paycom Software looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

I will like Paycom Software better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.