If there's one quirk of Wall Street thinking that continues to confound me, it's this: Why do investors continue to think that earning more profits on less revenue is a bad thing?

Take, for example (admittedly not a random selection) the earnings report that Paychex (NASDAQ:PAYX) put out yesterday. Wall Street analysts expected the company to earn $0.41 per share on $540.4 million in revenue. Paychex did indeed earn the $0.41 per share, but it did it on revenues of only $534.1 million.

Now, isn't that a good thing? Management earned exactly what everyone wanted to earn, and did it on less revenue than Wall Street expected. In fact, revenue still grew 5%, from $507 million to $534 million. To me, making the same profit as expected on less revenue than expected suggests that the company is more profitable than anyone thought. For example, if Paychex had booked $540.4 million in sales, as expected, and earned the same operating profits that it in fact did, that would work out to a 41% operating margin.

Instead, the company generated a 41.5% margin. Better than expected. Far better than anything you're likely to see out of rivals ADP (NYSE:ADP), Administaff (NYSE:ASF), Intuit (NASDAQ:INTU), or Hewitt Associates (NYSE:HEW) in the near future.

Great Caesar's ghost!
Listen, I'm not here to praise Paychex -- but I don't think it's right to bury it for a "revenue miss," either. The stock's down today, and there are plenty of good reasons for that:

  • For one thing, free cash flow for the quarter declined by a good 15% year over year.
  • For another, management still makes shareholders trudge over to the SEC's website for the 10-Q filing, so that we can dig out the cash-flow info. And yes, this unnecessary and shareholder-unfriendly practice raises my suspicions when I see that the cash flow data in question is bad news.
  • And as I've said before, I do still believe the stock is overpriced.
  • Finally, sales did come in light; however, management still predicts 6%-8% revenue growth.

All that being said, management's sticking to its projections of 2% to 4% profits growth. Based on yesterday's performance -- earning what it was supposed to earn on less revenue than it was supposed to bring in -- I wouldn't bet against Paychex hitting that target.

Fool contributor Rich Smith owns no shares of any company named above. Paychex is a Motley Fool Income Investor recommendation, and Administaff is both a Motley Fool Hidden Gems PayDirt selection and a Motley Fool Inside Value pick. The Motley Fool has a disclosure policy.