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Is Paychex the Perfect Stock?

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Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Paychex (Nasdaq: PAYX  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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.

Factor What We Want to See Actual Pass or Fail?
Growth 5-Year Annual Revenue Growth > 15% 5.5% Fail
  1-Year Revenue Growth > 12% 0.6% Fail
Margins Gross Margin > 35% 68.2% Pass
  Net Margin > 15% 24.2% Pass
Balance Sheet Debt to Equity < 50% 0% Pass
  Current Ratio > 1.3 1.15 Fail
Opportunities Return on Equity > 15% 34.7% Pass
Valuation Normalized P/E < 20 25.50 Fail
Dividends Current Yield > 2% 3.7% Pass
  5-Year Dividend Growth > 10% 17.7% Pass
  Total Score   6 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

With a score of 6, Paychex does a pretty good job on our measures. The company has shown how sensitive it is to economic conditions in the past several years, but with the economy on the rebound, prospects at Paychex are starting to improve as well.

Paychex provides payroll processing and HR services to businesses. So when businesses are suffering and either go out of business or lay off workers, Paychex sees lower revenue. That certainly bears out in the recent past, as revenue growth came to a screeching halt during the company's 2009 and 2010 fiscal years.

Now, though, things are on the upswing. The company's most recent earnings report showed a healthy rise in total service revenue on the back of particular strength in HR services, reflecting a potential resurgence in job-related activity.

From a financial perspective, the company is the best in the business. It boasts better margins and internal returns than primary rival Automatic Data Processing (Nasdaq: ADP  ) , as well paying a higher dividend. Moreover, Paychex's niche is very lucrative compared to the lower-margin staffing business where Korn/Ferry (NYSE: KFY  ) has to work a lot harder to eke out profits.

Paychex has some obstacles to overcome, but it also has some great opportunities. If new CEO Martin Mucci can follow through on initiatives to improve product cross-selling and raise productivity with better tech tools for its employees, Paychex could get a lot closer to perfection in the years to come.

Keep searching
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.

Click here to add Paychex to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Fool owns shares of Paychex, which is a Motley Fool Inside Value selection. Automatic Data Processing is a Motley Fool Income Investor pick. 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 Fool has a disclosure policy.

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