When we asked the community to list promising high-growth companies for our high-growth investment study last autumn, the company listed most frequently was Paychex (Nasdaq: PAYX). Surpassing 50 other contenders, Paychex has since moved to our small list of high-growth company finalists. Paychex shares this mantle with the following five other finalists:
Right out of the gate, Paychex is the early leader because it is the only company on the list to offer a dividend reinvestment plan, and its plan is free o' charge. In order to regularly purchase any of the other five companies, we would need to use a low-cost broker, and the lowest cost that I've seen is about $3 per trade. When you're only investing $100 a month, that cost is meaningful.
So, Paychex is the company to beat because buying it would earn us at least 2.5% in higher annualized returns versus the other five investments, each of which would make us lose at least that much to commissions. Given that, one of the other five companies will need to shine brighter than a baby's bald head to convince us that it's worth the cost.
All that said, we still need to determine that Paychex itself is worth our investment.
Paychex is a services company, providing payroll, tax, and human resource services mainly to small and medium-sized businesses. Since most of the country works for small and medium-sized businesses, chances are that many of you reading this right now are served by Paychex every few weeks.
Paychex makes money primarily by charging for payroll and tax services and by investing the money that it continually generates through operations -- money called "float." When Paychex doles out pay stubs across the country every week, it deducts taxes from each check, but it waits several weeks before that money is sent to the tax man. In the meantime, Paychex is able to invest that money in stable, short-term vehicles to earn itself a substantial amount of investment income.
That's a nice business, especially when coupled with continued growth in clients. Paychex has the luxury of selling a necessity -- necessary by law, for one. So, Paychex's sales reps mainly need to convince potential clients that its payroll service is better than the services of smaller competitors, and better than its major national competitor, Automatic Data Processing, Inc. (NYSE: ADP). ADP is the largest payroll service company in the country.
Paychex's CEO Tom Golisano has long stated that Paychex's long-term growth model calls for:
- 11% to 13% annual client growth, dependent on each of its sales reps selling 150 new accounts annually
- 2% to 3% annual price increases for existing services
- 2% to 3% annual growth in sales from new services
Add these three together, and the company has been able to achieve annual sales growth of more than 20% and annual earnings per share growth above 30% year after year. Earnings grow more quickly than sales because the company's costs are fairly constant even as the business grows.
Paychex was founded in 1971 and went public in 1983, so it isn't a spring chicken the way that, say, Angelina Jolie is.
Although few corporate histories are as impressive as Johnson & Johnson's (NYSE: JNJ), Paychex's history does shine, especially in the last decade. The company has grown net income 31% annualized since 1983, and 35% annualized for the last 10 consecutive years. Meanwhile, the stock has risen about 43% annualized the past decade. This means that Mr. Buffett could have just bought Paychex and done better. The following is the company's recent sales and earnings growth history:
1996 1997 1998 1999 2000 2001(YTD) Revenue growth (%) 22.5 20.0 23.5 21.0 21.9 20.6 Income growth (%) 36.3 35.6 36.0 36.1 36.6 35.2
That consistent income growth is just sublime, and it goes a long way in supporting the stock's current 60 P/E. The logical question to ask, however, is can this growth continue? Surely it can't, and we don't expect it to -- not at these levels.
However, it is very possible that a great deal of market-beating growth remains to be seen from Paychex. ADP is nearly 50 years old, and it has achieved just shy of 40 consecutive years of record quarterly growth. Got that? ADP has made a new record in sales and earnings every quarter for the past 40 years, or for 157 consecutive quarters. Paychex could keep growing in the same way.
Paychex and ADP grow with the economy, and in America, where starting a business is easier than it is anywhere else in the world, the number of businesses in operation continually rises, and each needs payroll and tax services. Overall, as long as the economy grows, leading payroll service providers should grow, and grow nicely, as well -- at least over the long run (bumps and hiccups will naturally occur).
There is much more to consider, including new competition, valuation, and we must run Paychex through our high-growth investment criteria. Let's talk about the company together before next week's column. Meet us on the Drip companies board.
Jeff Fischer is thinking about starting a payroll services company. He'll call it Paychecks. He doesn't own shares in Paychex. You can view his holdings online, as well as The Motley Fool's full disclosure policy.