Paychex (Nasdaq: PAYX) was bodychecked for a 6% decline on four times normal trading volume after announcing fourth-quarter results. The quarter's net income of $67.8 million, or $0.18 per share, was flat with last year. Revenue increased 7% to $244.3 million.

The announcement capped a difficult but successful year for Paychex -- a year during which interest rates were lowered 11 times, clients' payrolls dwindled due to layoffs, and new companies seeking services were fewer and farther between.

Despite all that, Paychex saw fiscal 2002 revenue grow 10% to $954.9 million, while net income gained 8%  to $274.5 million, or $0.73 in diluted earnings per share. At $30 per share, the stock trades at 41 times trailing earnings.

"Forty-one times!"

Yeah, it doesn't look inexpensive; it never has. And the stock could easily decline to new 52-week lows from this valuation. However, we did call the stock a good value when it last touched $31, after falling nearly 50%, in October 2001. How can it be a decent long-term value at these prices? One can't forget the company's long, amazing growth record; nor overlook its strong, lasting competitive position in a necessary service; nor overlook that Paychex did grow earnings 8% again this year, even in one of the more-difficult environments imaginable.

Given all this, when the economy improves, Paychex's results could go from fair and stable to exceptionally strong again.

In the interim, management expects 8% to 10% sales growth in its new fiscal year (2003) that ends on May 31, 2003. And it expects net income growth approximating or slightly less than sales growth. If we suppose 8% net income growth, the stock trades at 38 times year-ahead earnings per share. The company's new cash flow statement isn't available, but the stock trades at 38 times last year's free cash flow, and that probably hasn't changed much. Again, it doesn't look inexpensive.

So, should we buy more Paychex? Some -- here's why
The day after falling 6%, Paychex bounced back 4%, showing typical resiliency even in a weak stock market. That said, since March, the stock has fallen 28%.

So far, we've only made our initial purchase of Paychex (at $36.46) and haven't added more money to its free dividend reinvestment plan. We do need to start averaging into the stock. I feel comfortable doing so now for a few reasons, in addition to the company's strengths listed above and in past columns.

Continued growth in service revenue is one reason that I'm happy to buy more shares. Service revenue includes payroll services, human resource services, and employee benefit product lines. Even during the difficult last year, these revenues grew 13% to $892.2 million.

The gain is the result of more clients (once again showing Paychex's marketing abilities), more sales of ancillary new services (showing how the company continues to innovate and execute), and price increases (showing again how the company has pricing power). This three-pronged growth strategy has worked for years at Paychex, and should continue to work, making even sharp economic downturns less harrowing.

Another reason why I'm willing to average into more shares of the stock is that the company's profit margins have held up under fire.

Year ended...    May 31, 2001    May 31, 2002
Gross Profit        76.9%           76.8% 
Operating Profit    38.7%           38.0%
Net Profit          29.3%           28.7%

Strong profit margins in a weak environment indicate that Paychex is not a capital-intensive business. Unlike Intel (Nasdaq: INTC) and so many other modern companies, Paychex doesn't have production facilities that must run near capacity to keep profit margins high -- or to be profitable at all. Paychex operates an efficient service-based business without expensive overhead or facility upkeep (or inventory). Therefore, it remains highly profitable even when sales growth stalls. This is always a key business quality to seek.

Paychex continues to have the best net-profit margins of any of our holdings, and tops most all other companies, too.

Paychex also has a strong balance sheet, with $731 million in cash and equivalents, up from $613 million last year. And it carries only $5.6 million in long-term liabilities. (Please note that a table we ran last week showed Paychex had $3 billion in cash and equivalents. That included funds held temporarily from client payrolls. We don't want to include those. MultexInvestor, a site with convenient information, did include those funds, reminding us that we need to doublecheck such figures.)

A final reason why I'm willing to buy more shares now: Interest rates are near-record lows. Paychex earns significant interest on funds withheld from client payrolls (called "float"). Last year, interest earned on these funds decreased 25% to $62.7 million. Despite this, gross margins held steady. When interest rates start to rise again (and eventually they will), Paychex should benefit from higher income and, possibly, even higher margins.

Four purchases in process
Paychex offers a free dividend reinvestment plan on We're going to invest an additional $100 with it in the next five business days. Yesterday, we sent our checks in the same amount to buy more Johnson & Johnson (NYSE: JNJ), Mellon Financial (NYSE: MEL) (which fell yesterday due to its $100 million loan exposure to WorldCom), and Pepsi (NYSE: PEP), as explained last week. So, we're sending money into this maelstrom of a stock market -- money we don't plan to withdraw for another 15 years. We think we'll get some good prices.

To discuss Paychex, visit its discussion board. Have a great week!

For better or worse, Jeff Fischer owns the stocks in Drip Port, as shown online per the Fool's suave-as-chocolate-mousse disclosure policy. Right now, he's also trying to save money to put into a ROTH IRA.

Drip Port's Simple Returns as of 6/26/02 Market Close:

Drip Port: -5.9%
S&P 500:    3.9%
Nasdaq:    -8.5%

These are Drip Port's straight or simple returns (including fees and our Campbell Soup loss) since launching 7/28/97 (but not accounting for the fact that we dollar-cost average, which, when accounted for, accurately increases our return by typically a few percentage points). Because we started with a small investment base, $500, and add money every month, much of our money has not been invested long. Additionally, we've received $54.10 in reinvested dividends since September 2001 that have not been recorded in our numbers yet, due to functionality issues with our tracking provider. Thank you for your interest and patience.