Paychex Predicts a Pay Cut

By Rich Smith September 27, 2007

3 Recommendations

Once again, the stock market proves the old maxim: "You can please some of the people some of the time, but others will insist the glass is half empty." Or something like that.

However the saying goes, we're seeing it in action today, in the wake of payroll specialist Paychex's (Nasdaq: PAYX) fiscal Q1 2008 earnings report, released after the close of trading yesterday. On the plus side, Paychex beat estimates by the proverbial penny, earning $0.40 per share. On the minus side, it:

Fell a bit short on sales, with revenue coming in only 10% higher, at $507.1 million for the quarter
Predicted "relatively flat" interest income from funds held for clients, which it blamed on the Fed's recent 50-basis-point rate cut
Scaled back its profits-growth predictions. Where it previously predicted 15% growth for the year, Paychex now foresees something like 13%.

Forewarned is forearmed
Earlier this week, I cautioned investors that even when Paychex was expecting 15% net profits growth (all of three months ago), hitting that estimate would still leave the company a nickel short of Wall Street's consensus guidance for the year. I warned that unless Paychex exceeded its guidance, "2008 could be a year ripe with disappointment for shareholders."

Well, we're only one quarter into fiscal '08, and disappointment already abounds. With growth guidance now dialed back to 13%, Paychex needs to earn at least $1.53 per share to make the Street happy this year. You might assume that the firm's earnings warning is now priced into the stock after today's weakness. But that would be a foolish conclusion, not a Foolish one.

At the $1.53 per share projected, Paychex currently sells for nearly 31 times earnings. That seems like an awfully steep premium to pay for the 13% growth that Paychex predicts. It's even expensive for the 15% growth that, according to Wall Street's latest estimates, the experts still think it can achieve.

As wonderful a company as Paychex is, and as much as its profits beat those of rivals ADP (NYSE: ADP), Ceridian (NYSE: CEN), and Administaff (NYSE: ASF), Paychex still has plenty of room to fall. Tread warily around this one.

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