I’ve been scratching my head about Paycom software. The growth rate is much lower than other stocks at the same valuation. So I’m trying to figure out why it is trading so much higher.
So I’m looking at FCF and noticing that Paycom’s got it pretty good. Some of our favorite stocks still have negative fcf. Maybe that is the rub. Comparing already profitable companies on an operating basis, Paycom has a higher P/S valuation than TTD even though the growth rate is much lower, but Paycom has a lower p/fcf valuation, so maybe it isn’t trading at a premium after all…
I just read a fool article that talked about FCF as the important metric to look at for growth stocks as we head into a recession.
So if I may go as far as to ask a general question, does anyone look into fcf when evaluating companies? If so, why, and if not, why not? I noticed that the “oomph factor” does not look at free cash flow, and when people bring up the rule of 40, they are often looking at operating margin.
So if I may go as far as to ask a general question, does anyone look into fcf when evaluating companies? If so, why, and if not, why not? I noticed that the “oomph factor” does not look at free cash flow, and when people bring up the rule of 40, they are often looking at operating margin.
FCF, is it for the birds?
It’s a good question. However most of our little SAAS/like companies do not produce any cash flows from operations or FCF. Some quarters they do produce some positive cash flows, but because of their size (smallish) and their growth status (Hyper-growth) they are investing very heavily in R&D and Sales and Marketing expenses. There are a few exceptions here and there (like Zoom for example), but I believe many of these companies will be future cash flow cows due their amazingly high margins. AYX for example could be cash flow positive anytime they want with 90% margins. However they would risk losing market share to competitors at the expense of growth. We will all be watching as these companies scale, and we should see the % of R&D and S&M become lower and lower as a % of total revenue.
Bobby. I think you are correct. For a few companies, namely PAYC and VEEV, also TEAM, the market is awarding them a high multiple for their FCF. I definitely look at it when possible. In some cases it’s reported, otherwise you have to calculate it. When possible, I calculate rule of 40 three ways, using 1) non-gaap operating margin, 2) adjusted EBITDA margin, and 3) FCF margin. A lot of companies don’t have positive FCF or it’s super lumpy (eg TTD). In the case of lumpy I look at ttm FCF. I think TTD and AYX have a future that looks very similar to VEEV. Also pay close attention to what management says they are optimizing for. MDB and ZS, for example, are in full-blown land and expand mode. FCF is not the goal. Creating a category crushing juggernaut business is the goal. Cash flow will follow. There’s no reason to expect or even desire it at this stage. Likewise, if PAYC and VEEV suddenly started claiming cash flow isn’t important because they’re investing heavily in cap ex I’d be extremely suspicious. Same for TEAM, if suddenly they needed to spend heavily on marketing you’d know something isn’t right. Days like today are when you get an opportunity to look past the noise and confusion and buy into that future cash flow, or the current cash flow if that’s more your thing. Just some thoughts from someone who is learning this stuff as well.