Fool Shorts PAYX
August 04, 1994

Paychex, Inc. (NASDAQ: PAYX)
TYPE: Darling/Highflyer
Phone: (716) 385-6666
Closing prices, August 4th, 1994: Bid $33 1/4, Ask $33 3/4

Trailing 12-month revenues: $224 million
Trailing 12-month EPS: 93 cents
Last quarter reported: May, 1994 (FY 1994 end)
Next quarter report date: About September 15th
Consensus EPS estimate for quarter: $0.28e vs. $0.22

FOOL ratio: 1.38

TRADE: Shorting 150 shares, August 5th

Paychex, located in Rochester, New York, is a leader in payroll processing and tax preparation for small companies. A Lilliputian cousin of Automated Data Processing, the company provides services that allow small businesses to enter payroll data over the computer, transfer wage payments directly into their employees' bank accounts (electronically), and automatically file federal, state, and local taxes.

RAPID GROWTH. The company's year-to-year EPS growth rate has, as is the case for most of our shorts, been phenomenal. Paychex posted EPS numbers of $0.33 in 1991, $0.47 in 1992, and $0.67 in 1993 (all numbers adjusted for a split in August, 1993). Recently reported fiscal (May) 1994 earnings came in at $0.93 per share.

BUT NOT SO RAPID ANYMORE: The company's payroll processing unit, which cranks out about 80% of annual sales, is a fine operation that has captured a nice chunk of the small-business market. Businesses with fewer than 50 employees constitute 93% of American industry. But the tax-preparation and accounting side of the business are increasingly threatened by more powerful personal computers and software. And because computer hardware and software is only getting better and better, a Fool may be forgiven for wondering how much longer small companies are going to outsource their accounting needs when companies like Intuit and State of the Art are selling cheaper do-it-yourself packages. Combine this with Paychex's annual loss of 20% of its customers and no wonder earnings growth isn't projected to be what it once was.

The latest issue of Zacks lists Paychex's EPS estimates for the next two years at $1.16 per share and then $1.47 per share. If you've read our Fool Ratio article in the Novice Area, you know that's 26% annualized growth. Thus, the Fool Ratio shows this stock trading at 38% over its full value. Fools know what that means.

RECENT TRADING ACTION: After ascending the mountain to $40 late this February, Paychex got beaten up soon after we shorted it in our bygone print-publication portfolio at $39 1/2. The stock had dropped to $28 by late June, as NASDAQ stocks took a general beating and Paychex took a more specific one. Perhaps PAYX shareholders came to realize that not many companies with 17% projected revenue growth should be trading for very long at 49 times earnings.

The stock has rebounded a bit, as of late, partly on the strength of a Smith Barney upgrade of the stock to near-term buy last July 11th. One month before, Merrill Lynch had also upgraded the stock to near-term buy. We view both these developments as bullish for short sellers.

SHORT INTEREST REMAINS EXTREMELY LIGHT. What's left after everyone has already bought? A final reason we like PAYX as a short is the very low current level of short interest out on the stock. This number is reported once a month, appearing in your financial daily during the third or fourth week. Paychex, which trades on average more than 200,000 shares daily, had only 103,000 shares shorted as of July 15th. That means that on an average day, the entire short interest could be covered on the stock and then some. Ergo, a lot more selling remains to be done.