Stock Analysis

Paycom Software (NYSE:PAYC) Might Be Having Difficulty Using Its Capital Effectively

NYSE:PAYC
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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Looking at Paycom Software (NYSE:PAYC), it does have a high ROCE right now, but lets see how returns are trending.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Paycom Software:

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

0.25 = US$379m ÷ (US$3.9b - US$2.4b) (Based on the trailing twelve months to December 2022).

So, Paycom Software has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 10.0% earned by companies in a similar industry.

Check out our latest analysis for Paycom Software

roce
NYSE:PAYC Return on Capital Employed February 28th 2023

In the above chart we have measured Paycom Software's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

When we looked at the ROCE trend at Paycom Software, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 32% where it was five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Paycom Software has decreased its current liabilities to 61% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Paycom Software's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Paycom Software. And the stock has done incredibly well with a 178% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

While Paycom Software doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

Valuation is complex, but we're helping make it simple.

Find out whether Paycom Software is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.