Newspaper article Sarasota Herald Tribune

Is Paycom Software's Stock Too Dangerous?

Newspaper article Sarasota Herald Tribune

Is Paycom Software's Stock Too Dangerous?

Article excerpt

THE RATIONAL INVESTOR

A stock can be too "dangerous" for a typical investor for many reasons, not just because the company is badly managed or has a flawed business model. It can simply be because investors have bid up the price of the stock of a promising company to unreasonably high levels.

Buying a stock is a wager on the company's future earnings. That's always risky, but it is more dangerous when the annualized long-term earnings-growth rate assumed is more than 20 percent, and the stock's price already appears to take those earnings into account.

One way to be alerted to this danger is when the stock's price- to-earnings ratio, or P/E, is many times the market's recent P/E of about 17.

Why do investors push a stock to such heights? The answers are excitement and hype. These can blind investors to a stock's real value. Also, these stocks are sometimes relatively thinly traded, so the most optimistic buyers set the price.

Consider Paycom Software, a company that has strong buy recommendations from analysts even though it has a triple-digit P/ E. Paycom is in the business of cloud-based, human-resources software. The stock trades on the Nasdaq (ticker: PAYC). It recently traded around $38 a share and has more than doubled over the past year.

Some data investors should consider:

- The consensus forecast is for Paycom is to earn 36 cents in fiscal year 2015 and 47 cents in 2016. It earned 19 cents last year.

- Its consensus long-term earnings-growth rate forecast is 45 percent.

- PAYC's recent P/E, based on 2015 forecasted earnings and its recent $38 price, is 105 -- 200 based on 2014 earnings.

- Morningstar gives it a grade of "D" for profitability.

- Based on volatility, PAYC has about four times the risk of the S&P 500.

Since PAYC does not have dividends to support its price, let's pretend its forecasted 2015 earnings are dividends and see what that price supports. Using a 6 percent high-yield bond rate, we get .36 divided by . …

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