Paychex: Stable, Strong, and Cheap

• Email
• Share
• Print

One of the most important lessons investors can learn from last year's fallout is the consequence of investing in complex companies while acting like risk doesn't exist. Companies like Citigroup (NYSE: C) and Bank of America (NYSE: BAC) do everything humanly possible to complicate their business models, and they did so while leveraging to such insane levels that even an inkling of risk could (and did) destroy them.

That wasn't investing. It was gambling, on an extraordinarily stupid level.

Let me introduce you to what may be their polar opposite: payroll processor Paychex (Nasdaq: PAYX). The simplicity, profitability, and low-risk nature of this stock is the epitome of what a real investment should look like. In fact, we like it so much that we've deemed it worthy of the $2,000 in newfound savings Fool readers have amassed in the past month.

Here are five reasons I think Paychex deserves a spot in your portfolio.

1. Simplicity
This business is anything but rocket science. More than 70% of its revenue comes from payroll servicing -- a straightforward service you can wrap your head around with ease. Customers submit payroll data, and voila!, employees rejoice to see their bank accounts rise every other Friday. It's pretty simple.  

Those of you scorning or snickering at simplicity may want to think twice. Most "we're-gonna-change-the world" companies either outsmart themselves or are required to reinvent their business model every few years. The unglamorous nature of servicing payroll actually makes this company attractive.  

Rule No.1 when seeking out a superior investment: Keep it simple, Fool.  

2. Consistency
Sick of volatility? Good. One sentence from Paychex's 2008 annual report (fiscal year end May 31) tells a remarkable story of stability: "Fiscal 2008 was our eighteenth consecutive year of record total revenue, net income, and diluted earnings per share."

Think about that: 18 years of completely uninterrupted growth. Precious few companies can claim anything even remotely close. Investors should drool over that kind of predictability, especially with the kind of uncertainty we face today.

3. Profitability
This is a tremendously profitable cash cow of an industry by nature, but Paychex truly sits a cut above the competition. Have a look:

Company	Net Income Margin	Return on Equity	Dividend yield
Paychex	26.9%	44.8%	5.0%
ADP (NYSE: ADP)	13.6%	24.3%	3.6%
Administaff (NYSE: ASF)	2.9%	23.5%	2.4%
Intuit (Nasdaq: INTU)	14.3%	23.4%	N/A

Trailing 12 months. Data from Capital IQ, a division of Standard & Poor's.  

4. Strength
Credit-market tsunami? Bring it on! As the rest of the economy wanders around aimlessly, wondering how it'll finance tomorrow's bills, Paychex is 100% debt-free and holds a nice slug of cash on its balance sheet.

5. Opportunity
Let me be clear: raging unemployment is not good for Paychex. Even worse, the small businesses this company relies on are the same ones shafted when bumbling giants like General Motors (NYSE: GM) and AIG suck up all the bailout money. So why in the world do I still like this stock? Because the pain is already priced in.

With shares down 26% in the past year, investors have the opportunity to snag this company at around 16 times 2009 earnings estimates. While that may not sound like screaming-bargain territory – it's not -- it's nonetheless cheap for a company with earnings this consistent and predictable.

Many investors sneered, and rightfully so, as Paychex's shares frequently traded for more than 30 times earnings in years past. Those days are gone. Even if growth ebbs from its 18-year winning streak and earnings sputter (which will happen), Paychex is conservatively priced to provide ample returns in the years ahead -- especially once the economy regains traction. Premium stocks deserve premium multiples, and that's exactly why 16 times forward earnings here looks like a steal to me.

Who should invest in Paychex?
Glad you asked, because this one isn't for everyone. If you're looking to make an overnight killing, you won't find it here. This one's for long-haul investors who understands the glorious power of compounding; the kind of investors who are satisfied with steady, stable, long-term returns without an outsized amount of risk.

Add it up, and you'll see why Paychex is a "Buy Now" pick from our Motley Fool Inside Value newsletter, as well as a "Buy First" recommendation from our Income Investor team. If you're interested in more of these slow-but-steady stocks that aren't nearly as prone to the gut-wrenching collapses of the past year, give Income Investor a try free for 30 days. There's no obligation to subscribe.

Now that our Fiscal Fitness challenge readers have saved up $2,000, we're sharing two more stock ideas for that newfound cash hoard. Learn the identity of those two stocks, and read more about the rest of the money-saving tips, right here.

For related Foolishness:

• The Worst Investment in 50 Years
• How Low Can Stocks Go?
• Are Your Dividends Safe?