Three months ago, payroll processor Paychex (NASDAQ:PAYX) promised that by fiscal year-end it would be reporting 12% better profits than it had earned last year. On Thursday, management did just that -- but not just that.

In addition to 12% growth in net income for fiscal 2008, Paychex reported:

  • 10% revenue improvement.
  • 16% growth in earnings per share (to $1.56 for the year).
  • 15% more cash generated from operations -- $725 million in all. (However, we do not yet know the free cash flow figure. Whereas last quarter Paychex filed its 10-Q with attached cash flow statement on the same day it released earnings, this quarter we're still waiting for that document to show up in the 10-K filing.)

There was just one promise, actually, on which Paychex failed to deliver. Last quarter, management told us that its human resources outsourcing division would post revenue growth in the low 20th percentile range for the year. It came up just shy of that level at 19%. Objectively speaking, though, 19% is not too shabby, and it's more than twice the pace of growth set by Paychex's core payroll division.

Granted, investors don't seem entirely enthralled with the news. Blame "the market's" recent malaise all you want, but the fact remains that Paychex shares sit 1% lower today than they did before the earnings news broke. I think that's a mistake.

Macro vs. micro
Sure, on a macro level, Paychex's success is tied to the general health of the economy, and Paychex's customers help make up that economy. But you could say the same thing about any of the company's rivals: ADP (NYSE:ADP), Administaff (NYSE:ASF), Intuit (NASDAQ:INTU), and Hewitt Associates (NYSE:HEW). What's key here is that at $2 billion in annual revenue, Paychex is smaller than any of these competitors, save Administaff. That means Paychex still has a lot of room to grow -- both after the economy perks up and during the downturn, should Paychex succeed in stealing market share from rivals.

Moreover, Paychex is proving to be an eminently scalable business. Last year, with sales up 10%, "total expenses" rose less than half as fast -- up just 4%. Now, Paychex's 40% operating margin already puts its rivals to shame. Imagine how much more chagrined they'll be as the company continues to reap economies of scale.

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