I'm a big Paychex (Nasdaq: PAYX) fan. I love the payroll processor's simplicity, its capital-light business model, its ability to milk interest off other people's money, and its 4.8% dividend yield.
But that last part, the dividend, is making some investors nervous. Take a look at Paychex's dividend as a percentage of net income, and things look a bit stretched:
|
|
2010* |
2009 |
2008 |
2007 |
|---|---|---|---|---|
|
Dividend/Net Income |
94% |
83.9% |
76.7% |
58.5% |
Source: Capital IQ, a division of Standard & Poor's.
*Year ended May 31.
That's ugly. Paychex has reached a point where just about every penny it makes is shipped off to shareholders. Why is that bad? Because even a slight profit setback could lead to a dividend cut or other less-than-honest ways to keep the payment going, like borrowing or equity sales.
At least that's what the critics might say.
Digging deeper
But I'm not too worried. As mentioned, I love Paychex because its capital expenditure needs are trivial. More importantly, the company has a habit of depreciating assets more than it spends on capital expenditures. (See here for more on the cash flow statement.) All this means is that free cash flow -- a more important metric than net income -- makes Paychex's dividend look far less stretched than the income statement implies:
|
|
2010 |
2009 |
2008 |
2007 |
|---|---|---|---|---|
|
Dividend/Free Cash Flow* |
81.6% |
71.7% |
68.8% |
54.6% |
Source: Capital IQ, a division of Standard & Poor's.
*Cash from operations-capex.
That isn't bad at all. Paying out 81.6% of free cash flow is hardly conservative, but it's nothing to fret about. This dividend is safe for the time being.
Even so, some worry this payout level is still pushing the limits of prudence and puts Paychex in jeopardy of a future dividend cut should the economy continue to rot. There's no margin of safety, the critics might say. There's little room for error.
Then again, it depends on how we're defining margin of safety. Paychex's 4.8% yield is extremely high for a company that's grown its dividend by 19% per year over the past decade -- especially while Treasury bonds yield close to nothing. This outsized yield can partly be explained by the company's growth rate taking a breather amid rampant unemployment. But another reason might be that the market is already forecasting a future dividend cut.
Sounds nasty, but I don't think that's a bad thing given how high the current yield is. Investors should take comfort in this knowing that, look, this dividend can be cut, and shares are still probably a good value. The bad news is already baked into the cake. If Paychex's dividend is cut to, say, a 3.5% yield, no one can reasonably complain. It'd still be an attractive yield for a company of this caliber.
But if the mere thought of a dividend cut makes you squirm, I don't blame you. Investors want certainty these days. Here are six other companies with high dividend yields and low payout ratios:
|
Company |
Dividend Yield |
Payout Ratio |
|---|---|---|
|
Bristol-Myers Squibb (NYSE: BMY) |
4.8% |
22% |
|
DuPont (NYSE: DD) |
3.9% |
48% |
|
Abbott Laboratories (NYSE: ABT) |
3.4% |
48% |
|
Procter & Gamble (NYSE: PG) |
3.2% |
43% |
|
Intel (Nasdaq: INTC) |
3.2% |
35% |
|
Sysco (NYSE: SYY) |
3.2% |
50% |
Source: Capital IQ, a division of Standard & Poor's.
Chin up, investors
Is Paychex's dividend in jeopardy? I don't think so. But what's important is that the stock seems priced for it anyway. That's a great position for investors to be in: heads, you win; tails, you're still all right. The probability of success is stacked in your favor -- that's when investing gets fun.
Interested in high-yield investments? Fool analyst Jordan DiPietro says this is easily the most popular dividend stock.
