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The Best Growth Stock You're Totally Overlooking

What do Oracle (Nasdaq: ORCL  ) , Microsoft (Nasdaq: MSFT  ) , and Intuitive Surgical (Nasdaq: ISRG  ) have in common? Well, a lot, admittedly, but here are the two big things I've got in mind.

  1. They've made a lot of people fabulously wealthy.
  2. They've each got a rare trifecta of durable competitive advantages.

Scale advantages, valuable intellectual property, and high switching costs. Individually, any one of these can lead to market-drubbing success. The rare bird that possesses this trio of competitive advantages, though, has all the makings of a corporate ATM machine. That's why each of these names is on my watch list. That's also why Motley Fool Inside Value recently doubled down on our recommendation of Paychex (Nasdaq: PAYX  ) , possibly the best business you don't know a thing about.

Livin' it up
Paychex is a human-resources solutions provider for small- and medium-sized businesses, with its bread-and-butter being payroll processing. Rather than meddle with this complex, time-consuming administrative task, businesses line up to let Paychex handle it for them. More than 500,000 businesses, in fact, with more than 75% sticking around from year to year.

Payroll processing is like the Hotel California: You can check out anytime you like, but you can never leave. The switching costs associated with changing who handles your payroll are extremely high. It takes lots of time to evaluate competitors, manage the logistics of a transition, and train employees on a new system. As if that's not enough of a deterrent, Paychex also cross-sells a host of ancillary human-resource services, making a full-on switch all that more difficult. That's a pity if you're a customer, but that's music to this shareholder's ears.

The gravy train
Thanks to the toll-booth nature of the payroll business, processers like Paychex and fellow industry big dog Automatic Data Processing (NYSE: ADP  ) practically rake in cash. Not only do these guys collect fees for each check cut and cross-sell their myriad ancillary services -- payroll tax administration, 401(k) plan offerings, etc. -- they also collect interest on the funds they temporarily hold for clients. That interest historically makes up more than 13% of Paychex's operating profits and is virtually 100% margin, meaning only the tax man stops that gravy from dripping to the bottom line.

Paychex and ADP are the clear alpha dogs of payroll processing, with each boasting client logs with more than 10 times the number of clients as their next-biggest rival. You'd think that would mean Paychex's growth days are behind it, but the peppy truth is that only 10% to 15% of businesses in its target markets even outsource payroll processing. In other words, there's plenty of room left on this runway. And given Paychex's large sales force, strong brand, and breadth of support services, there's every reason to believe that Paychex will gobble up a larger slice of the growing market pie.

The opportunity
At Inside Value, we peg Paychex at $40 a stub, making for about 30% upside from recent prices. And this isn't some "value is its own catalyst" jive, either. Paychex is looking at a double-barreled catalyst: falling unemployment and rising interest rates. A rebound on the jobs front will equate to more checks cut, better pricing power, and higher customer retention rates -- all great news for Paychex.

The shares aren't without risk, of course. Unemployment won't turn overnight; nor will interest rates bounce upward until the Fed takes its foot off the gas. For that matter, there's always the chance competitors could invent a better widget or start pushing aggressive price cuts in response to the recession.

Then again, I'll put it this way: I own Paychex shares, and we at Inside Value rate them among our top eight Best Buys Now. You can try our service free for 30 days. There's no obligation to subscribe.

Joe Magyer owns shares of Paychex and Automatic Data Processing. Intuitive Surgical is a Motley Fool Rule Breakers selection. Microsoft and Paychex are Motley Fool Inside Value recommendations. Automatic Data Processing and Paychex are Motley Fool Income Investor recommendations. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (23)

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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 November 01, 2009, at 1:06 PM, PauvrePapillon wrote:

    If the objective is to find a multibagger in the making, you will need to find a company that is in a much earlier stage of its technology rollout than Intuitive Surgical. Here's a little help.

    When the market (correctly) understood that CyberKnife was a truly unique and revolutionary technology, investors bid Accuray’s post-IPO shares up to an intraday high of $31.09 (9 February 2007). As Varian and others made repeated claims, in numerous press releases, interviews and conference calls, that their gantry-mounted machines could do the same thing as the robotically controlled CyberKnife, Accuray’s market cap shrank even though its economic fundamentals actually improved.

    On 6 December 2008, Accuray, finally, fired back with the release of two animated videos that effectively demonstrate what CyberKnife is and why it is fundamentally different from gantry-mounted radiation sprayers. You can see them for yourself at

    Since then, Accuray shares have gone up 40.73 percent while Varian’s share price has risen only 4.14 percent versus an IHI index (medical equipment manufacturers) up 24.99 percent and a NASDAQ up 35.52 percent as of close of market Friday (31 October 2009).

    Now comes Accuray’s pre-ASTRO press release and you can see why Varian has been so hell-bent to confuse the investment community as to the capabilities of gantry-mounted, co-planer machines versus the robotically controlled, multi-planer CyberKnife.

    From Accuray Introduces the CyberKnife(R) VSI(TM) System:

    "'There is a tremendous need for the capabilities built into the new CyberKnife VSI,' said Dwight Heron, M.D., chairman of the Department of Radiation Oncology at UPMC Shadyside. 'Depending on each individual patient's case, we will now be able to better tailor care so that the right amount of radiation is delivered to the right place in the right time frame for each patient, all with the same accuracy for which the CyberKnife is known.'"

    Translation: Now that CyberKnife’s motion tracking real-time continual image guidance and robotic mobility can be applied to both conventionally fractionated IMRT as well as radiosurgery, every gantry-mounted radiation sprayer is obsolete.

    And since the new smaller footprint CyberKnife can fit in the same existing radiation vaults that now house obsolete Varian radiation sprayers, it’s time to move those antique, aged, obsolete, gantry-bound, deaf-dumb-and-blind Varian radiation sprayers into some museum somewhere.

    Accuray is Mercedes. Varian is Oldsmobile.

  • Report this Comment On November 01, 2009, at 1:25 PM, wolfman225 wrote:

    I have to question a couple of the assertions made. "Declining unemployment"? Where? Do you know something the rest of the country doesn't? Unemployment looks to be headed for double-digits. I expect to see 10.1% by Feb/March next year and staying around 10% for most of the summer, possibly falling by fall.

    As for the rising interest rates, that may happen eventually, but not in the near-term. There's still too much focus by the current administration to "stimulate" the economy. Rising interest rates will make it more expensive to borrow, impacting consumers ability to spend on big ticket items. With 2010 being an election year, don't look for the administration to do anything to possible alienate voters from the Democrat cause. I believe higher interest rates are coming, but not until 2011 or later.

  • Report this Comment On November 01, 2009, at 1:32 PM, wolfman225 wrote:

    As for the possibility of aggressive price cuts by retailers in response to the recession, all you need to do is look at the current book price wars as an early indication. Also, big chains like Wal-mart and Target have already started pushing the holiday sales season. I'm a truck driver delivering consumer goods. I was recently at a mall in the northeast where the CHRISTMAS DECORATIONS were already out well in advance of Halloween!

    Ah, for the "good old days" when the Christmas sales blitz didn't start until 12:01 am the day after Thanksgiving.

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