Over the past six months, Paylocity’s stock price fell to $150.91. Shareholders have lost 14.5% of their capital, which is disappointing considering the S&P 500 has climbed by 13.6%. This might have investors contemplating their next move.
Is now the time to buy Paylocity, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free for active Edge members.
Why Is Paylocity Not Exciting?
Even though the stock has become cheaper, we don't have much confidence in Paylocity. Here are three reasons why PCTY doesn't excite us and a 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 $378.9 million in Q3, and over the last four quarters, its year-on-year growth averaged 14.7%. This performance slightly lagged the sector 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 6.8%, a deceleration versus its 23.5% annualized growth for the past five years. This projection doesn't excite us and indicates its products and services will face some demand challenges.
3. Operating Margin in Limbo
While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain 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 might fluctuated slightly but has generally stayed the same over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 19.1%.
Final Judgment
Paylocity isn’t a terrible business, but it doesn’t pass our quality test. Following the recent decline, the stock trades at 4.8× forward price-to-sales (or $150.91 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're pretty confident there are superior stocks to buy right now. We’d suggest looking at an all-weather company that owns household favorite Taco Bell.
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