Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Paychex (Nasdaq: PAYX ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
- Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.
With those factors in mind, let's take a closer look at Paychex.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.9%||Fail|
|1-Year Revenue Growth > 12%||6.3%||Fail|
|Margins||Gross Margin > 35%||69.2%||Pass|
|Net Margin > 15%||24.9%||Pass|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||1.15||Fail|
|Opportunities||Return on Equity > 15%||35.8%||Pass|
|Valuation||Normalized P/E < 20||21.75||Fail|
|Dividends||Current Yield > 2%||4.1%||Pass|
|5-Year Dividend Growth > 10%||12.6%||Pass|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Paychex last year, the payroll processor has maintained its six-point score. Growth has actually picked up a bit in the past year, and the company's long-term dividend growth has continued.
Paychex provides payroll and HR services to companies. Unlike rival Automatic Data Processing (Nasdaq: ADP ) , which tends to focus on large businesses, Paychex counts smaller companies among its primary target area.
The slow economy has undoubtedly held Paychex back, as small businesses cut back and high unemployment has resulted in less need for payroll services. But while Paychex gets the majority of its revenue from the payroll segment, the company sees higher future growth in its HR services. That's consistent with trends that competitor Insperity (NYSE: NSP ) has seen, with a big boost in its earnings in its most recent quarter.
As the economy improves, Paychex will benefit. But the company faces new competition from Intuit (Nasdaq: INTU ) , which offers payroll-management services alongside its popular QuickBooks accounting software. With Intuit seeking to become a one-stop shop for financial solutions for small businesses, Paychex will have to figure out how to respond to defend its market share.
For Paychex to get closer to perfection, the company needs to continue seeking out new sources of revenue. If it can broaden its reach, Paychex could not only block Intuit's charge into the space but also displace it as the best service provider in the industry.
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.
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