Is Paychex Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Paychex (NASDAQ: PAYX  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Paychex's story, and we'll be grading the quality of that story in several ways:

  • Growth: are profits, margins, and free cash flow all increasing?
  • Valuation: is share price growing in line with earnings per share?
  • Opportunities: is return on equity increasing while debt to equity declines?
  • Dividends: are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Paychex's key statistics:

PAYX Total Return Price Chart

PAYX Total Return Price data by YCharts.

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

14.6%

Fail

Improving profit margin

10.4%

Pass

Free cash flow growth > Net income growth

16.1% vs. 19.7%

Fail

Improving EPS

18.9%

Pass

Stock growth (+ 15%) < EPS growth

43.1% vs. 18.9%

Fail

Source: YCharts. *Period begins at end of Q1 (Feb.) 2010.

PAYX Return on Equity Chart

PAYX Return on Equity data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

0.2%

Pass

Declining debt to equity

No debt

Pass

Dividend growth > 25%

112.9%

Pass

Free cash flow payout ratio < 50%

91.3% 

Fail

Source: YCharts. *Period begins at end of Q1 (Feb.) 2010.

How we got here and where we're going
Paychex's five out of nine passing grades are a little disappointing considering its rather solid position in the American employment chain. However, these results do reflect the anemic nature of America's recovery, as Paychex seems to be only barely ahead of inflation (these are three-year metrics, after all). What does the future hold for Paychex as it struggles to grow in a difficult jobs market against several muscular payroll-processing competitors?

Paychex's quarterly report -- scheduled for tomorrow -- should shed more light on its progress. The company's small- and mid-sized business target market is getting increasingly crowded. Automatic Data Processing (NASDAQ: ADP  ) pushes in from above (it typically works with larger companies) with the option to deposit paychecks into a prepaid Visa card. Intuit (NASDAQ: INTU  ) , maker of TurboTax and other small-business software, is pushing up from below with cloud-based payroll software that allows really small businesses to manage employee paychecks with a greater degree of control.

Paychex is fighting back through diversification, as it recently bought an HR staffing software-as-a-service company to improve its human resource options. That's more likely to fend off ADP than Intuit, which is targeted toward companies that have perhaps a half-dozen or fewer employees. That may not be enough to justify continued investor optimism in the company -- Fool contributor Rich Smith, while analyzing ADP, discovered that Paychex has the slowest historical growth rate and the lowest anticipated forward growth rate of the pack.

Putting the pieces together
Today, Paychex has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

What macro trend was Warren Buffett referring to when he said, "this is the tapeworm that's eating at American competitiveness"? Find out in our free report: "What's Really Eating at America's Competitiveness." You'll also discover an idea to profit as companies work to eradicate this efficiency-sucking tapeworm. Just click here for free, immediate access.

Keep track of Paychex by adding it to your free stock Watchlist.


Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 25, 2013, at 4:26 PM, jaybird43 wrote:

    Maybe you should revisit the dividen. Payx is on a quarterly but shareholders have not seen a divident this year. The last one was in dec. That begs the question-cut or are we going semi-annual. Either way that makes me a seller.

  • Report this Comment On June 25, 2013, at 4:59 PM, spartancb11 wrote:

    Alex you should really research more about the companies you write about. Jaybird isn't all that knowledgeable either. Coming into the end of 2012 in anticipation of the tax increase Paychex paid the 3rd and 4th quarter dividends early. This makes your charts and rankings inaccurate. A great component of Paychex is as interest rates rise they will increase profitability due to the float on the billions of tax funds. They will be one of the few high paying dividend stocks to be rewarded when interest rates rise as oppose to investors shifting back to bonds.

  • Report this Comment On June 25, 2013, at 11:33 PM, crca99 wrote:

    Paychex paid dividend early to be nice to shareholders who wanted 2012 lower tax rates. Other companies did the same, e.g., Oracle. It just confused me.

Add your comment.

DocumentId: 2508936, ~/Articles/ArticleHandler.aspx, 7/26/2014 9:30:48 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement