A month ago I kicked off a series reviewing a handful of dividend-paying companies in the S&P 500. I narrowed down a list of the five companies with the highest yield and the five with the fastest-growing dividend payments over the past 10 years to four companies that I thought were compelling enough for further research.

Today we take a look at payroll and human resource services provider Paychex (NASDAQ:PAYX). Paychex made the cut by growing its dividend more substantially (on a percentage basis) over the past 10 years than any other company in the S&P 500 save Intel (NASDAQ:INTC).

The business
The company's primary business is providing payroll services to companies with 100 or fewer employees. In its 10-K, Paychex estimates that 99% of the 7.4 million employers in the markets it serves have fewer than 100 employees, and only 15% to 20% of those employers currently contract with a payroll service provider.

From the raw industry numbers, you can probably guess that payroll services has been a great business for Paychex. That assumption is backed up by average annual revenue growth of 15.3% for the past three years. But having many small customers cuts both ways -- smaller businesses are also more likely to fail. However, Paychex has been making headway on this front and is currently renewing better than 80% of its customers each year.

Competitors to Paychex in payroll processing and human resource services include Automatic Data Processing (NYSE:ADP), Administaff (NYSE:ASF), Ceridian (NYSE:CEN), and a number of small private companies that provide payroll services.

The financials
To put it bluntly, the financials at Paychex are a thing of beauty. Rather than spending 300 words describing them, here's a table with some of the important numbers.

5-Year Sales CAGR*


5-Year Free Cash Flow CAGR*


5-Year Average Return on Equity


5-Year Average Net Margin








Free Cash Flow**


*Compound annual growth rate. **Trailing 12 months.
Data provided by Capital IQ, a division of S&P.

There are a couple of other items to note. Like most service businesses, Paychex is not very capital intensive. Over the past five years, capital expenditures have averaged around 5% of sales. The other item is the interest the company earns on funds that it holds for clients before making payments to tax authorities. At the end of the most recent quarter, those funds stood at more than $3.8 billion. Since this income is a part of the company's operations, an adjustment to interest income for valuation purposes should only be made for the interest earned on the company's cash balances.

Valuation and final thoughts
I last took a look at Paychex on March 29, and I wasn't thrilled with the valuation with the shares trading around $41. At about $37.50 the shares certainly look more attractive now then just two months ago, having fallen close to 10%. Doing a discounted cash flow analysis (using a 9.5% discount rate), I find that top-line growth of 7% to 8% is priced into the shares for 20 years and then 3% thereafter. Those levels of growth are below what the company has averaged historically, but 20 years is a long period of time. In other words, the growth at Paychex is bound to slow. I'm inclined to wait for 5% to 6% growth to be priced in to allow for slowing growth in later years.

The current 1.7% yield on Paychex shares isn't quite enough to make the cut in our Income Investor service. But if there should be a dip in price in the next 12 months and the company continues its regular increases in payments, it is entirely possible that Paychex could meet that threshold and become a member of lead analyst Mathew Emmert's stable of undervalued, dividend-paying stalwarts. These are companies that -- like Paychex -- have delivered lots of dividend growth, but also offer better-than-average yields. The ranks include the likes of JPMorgan (NYSE:JPM), which rewarded investors with a 26% total return since its recommendation.

If you'd like to learn more about the market's best dividend payers, click here.

Nathan Parmelee has no financial stake in any of the companies mentioned in this article. Intel is a Motley Fool Inside Value recommendation. The Motley Fool has adisclosure policy.