Here's How Paychex May Be Failing You

Margins matter. The more Paychex (Nasdaq: PAYX  ) keeps of each buck it earns in revenue, the more money it has to invest in growth, fund new strategic plans, or (gasp!) distribute to shareholders. Healthy margins often separate pretenders from the best stocks in the market.  That's why I check on my holdings' margins at least once a quarter. I'm looking for the absolute numbers, comparisons to sector peers and competitors, and any trend that may tell me how strong Paychex's competitive position could be.

Here's the current margin snapshot for Paychex and some of its sector and industry peers and direct competitors.

Company

TTM Gross Margin

TTM Operating Margin

TTM Net Margin

 Paychex

67.8%

36.4%

24.0%

 Microsoft (Nasdaq: MSFT  )

80.7%

41.6%

31.3%

 DST Systems (NYSE: DST  )

22.1%

16.4%

12.4%

 Computer Sciences (NYSE: CSC  )

20.5%

7.6%

5.0%

Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

Unfortunately, that table doesn't tell us much about where Paychex has been, or where it's going. A company with rising gross and operating margins often fuels its growth by increasing demand for its products. If it sells more units while keeping costs in check, its profitability increases. Conversely, a company with gross margins that inch downward over time is often losing out to competition, and possibly engaging in a race to the bottom on prices. If it can't make up for this problem by cutting costs -- and most companies can't -- then both the business and its shares face a decidedly bleak outlook.

Of course, over the short term, the kind of economic shocks we recently experienced can drastically affect a company's profitability. That's why I like to look at five fiscal years' worth of margins, along with the results for the trailing 12 months (TTM), the last fiscal year, and last fiscal quarter (LFQ). You can't always reach a hard conclusion about your company's health, but you can better understand what to expect, and what to watch.

Here's the margin picture for Paychex over the past few years.

Source: Capital IQ, a division of Standard & Poor's. Dollar amounts in millions. FY= fiscal year. TTM = trailing 12 months.

(Because of seasonality in some businesses, the numbers for the last period on the right -- the TTM figures -- aren't always comparable to the FY results preceding them.)

Here's how the stats break down:

  • Over the past five years, gross margin peaked at 68% and averaged 67.3%. Operating margin peaked at 40.1% and averaged 38.2%. Net margin peaked at 27.9% and averaged 26.5%.
  • TTM gross margin is 67.8%, 50 basis points better than the five-year average. TTM operating margin is 36.4%, 180 basis points worse than the five-year average. TTM net margin is 24%, 250 basis points worse than the five-year average.

With recent TTM operating margins below historical averages, Paychex has some work to do.

If you take the time to read past the headlines and crack a filing now and then, you're probably ahead of 95% of the market's individual investors. To stay ahead, learn more about how I use analysis like this to help me uncover the best returns in the stock market. Got an opinion on the margins at Paychex? Let us know in the comments below.

Seth Jayson owned shares of the following at the time of publication: Paychex. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. Microsoft and Paychex are Motley Fool Inside Value recommendations. Motley Fool Options has recommended a diagonal call position on Microsoft. Motley Fool Options has recommended a write covered straddle position on Paychex. The Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On November 29, 2010, at 6:56 PM, gratianus wrote:

    Does the author have any clue as to what business Paychex is in? If his choice of peers for purposes of comparison is any indication, the answer is "NO." Paychex primarily is a payroll services company that caters to small and medium sized firms. I see little overlap with DST, Micrososft or Computer Sciences.

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