2023-08-03 18:26:14 ET
Summary
- Paychex gets a neutral / hold rating today, in line with the consensus from Wall Street and the Seeking Alpha quant system.
- Positives: YoY net income growth, capital and liquidity strength, dividend yield above sector average.
- Headwinds: valuation above sector average, share price well above 200 day moving average.
- Notable to mention: company is an industry leader and is involved with "AI" innovations in the payroll industry.
Research Brief
As we take a breather from this month's earnings calls, one company not reporting its next quarterly results until Sept. 27th is Paychex ( PAYX ), a brand that bridges the gap between technology, payroll & HR solutions.
Today's article theme is innovation, so I'll be reviewing this innovative payroll industry leader and whether it is a potential value buy for investors at this time.
Some notable points about this company, from its official website : it has 740K customers in US & Europe, 16K employees, trades on the Nasdaq and is headquartered in Rochester, NY.
Rating Method
I look for dividend opportunities and value plays among tech, financials, & innovation stocks. My rating analysis is broken down into rating 5 categories:
- Valuation, Dividend Yield, Net Income Growth, Capital & Liquidity, Share Price.
To earn a "hold" rating the stock has to win on 3 of the 5 categories, and 4 out of 5 to earn a "buy" rating.
Valuation: Not Recommended
To start off, I will look at the valuation of this stock, using two metrics, the forward P/E ratio and forward P/B ratio, taken from Seeking Alpha data .
The P/E ratio as of August 3rd is 26.61. With the sector average closer to 21x price to earnings, this valuation is over 27% higher than the sector average. I think it is overvalued, as my target range would be somewhere at or below the sector median, which would value it below 20.87 essentially.
As far as the P/B ratio, not much better news there. It is currently at 11.36 and even earned an "F" grade from Seeking Alpha Quant. Considering that the sector average is closer to 2.6x price to book, this stock's valuation is over 300% above the sector average! That is insanely overvalued in my opinion, as I would be looking for a price to book of somewhere closer to 2.5x.
In this case, this stock is not recommended on either valuation metric.
Dividend Yield: Recommend
There is better news when it comes to dividend yield. As of August 3rd, this stock's yield is 2.86%, with a dividend of $0.89 per share and the next ex-date of August 9th coming up very soon. This could be something for new or existing investors to take advantage of.
Further to mention, on another positive note, is that the dividend quarterly payouts have been steady and growing since 2020, as the table below shows. This shows a commitment to return capital back to shareholders.
Supporting that trend is also the following chart, showing the annual dividend going from $2.18 in 2018 to $3.03 in 2022, a nearly 39% increase over 5 years. While this is not a guarantee of future dividends, it is indicative of a solid growth in the last several years, some of which were economically challenging to many companies particularly in the era of pandemics and high interest rates. This company has proven it can weather those storms.
Now, in comparison to its sector average, this stock's dividend yield is an impressive 95% above the sector median, and even earned an "A-" grade from Seeking Alpha Quant ratings:
Based on the evidence, I highly recommend this as a dividend-income opportunity, a nice one to add to an existing dividend-income portfolio.
Net Income Growth: Recommend
What gets my attention is the solid YoY growth in both net income and earnings per share, as the income statement below shows:
Paychex CEO John Gibson had this positive outlook in his quarterly results commentary :
As we look into next year, we are well positioned to deliver on our purpose – to help businesses succeed. Our industry leadership and differentiated set of solutions will allow us to continue to serve our customers, our shareholders, and our communities.
With that said, let's look further into some top-line drivers of income for this company:
In the table above, we see this company's two service segments benefitted from YoY growth, but also notable to mention is the 69% YoY growth in interest earned on client funds held. This shows a relatively diversified revenue model, but also correlates well with the trend of rising interest rates over the last year driven by Fed rate hikes. This firm shows it has benefitted from that environment.
In terms of innovation, which I mentioned at the start, I think this firm is grabbing that bull by the horns as they say in Texas, and riding it:
Consider that this firm will likely see growth in some of the above segments going forward, particularly the role of artificial intelligence, analytics, and digital. When you think about it, a very large payroll firm like this is likely sitting on a mountain of data, and as I mentioned in an earlier article there is value in data especially when used for smarter decision making.
In fact, I think if Paychex can take a leading role when it comes to the role of "AI" in making payroll processes more productive, it can also be a revenue leader in this space going forward too.
Consider that a Reuters article this June highlighted the sentiment from one industry veteran who recognized that "AI" will be complimentary to the payroll industry rather than a replacement of it:
the founder of a human capital management advisory business assured payroll professionals that artificial intelligence will not replace their profession but instead transform it into a more collaborative process within a business.
Capital And Liquidity: Recommend
We will keep this section simple and focus on the data from the last quarterly presentation , as shown below:
I am impressed in both their operating cashflow and free cashflow figures, which improved YoY, as did their cash position. That, combined with the capacity to continue to grow dividend payouts to shareholders positions this as a company with solid financial fundamentals.
Enough said on that, it is clear they should be recommended as having a good capital and liquidity position.
Share Price: Not Recommended
The question I ask often is what price range would I consider a buying opportunity on a stock. To simplify things, I am using the following yCharts which tracks this stock's price vs its 200-day simple moving average. After market open on August 3rd, shares were trading around $124.53:
My investing idea calls for trading within a 5% range of the 200-day SMA. So, my buying range in this case would be $108.64 - $120.07, and with a goal of holding for 1 year. The current share price, however, is almost 9% above the moving average, so it is above that target range and I consider it too expensive. Interestingly, that correlates with the high valuation I discovered earlier in the article. It appears the market sentiment is overvaluing this stock right now.
Below, I will illustrate my investing idea within my target price range:
In the above simulated trade, 100 shares are bought at $108.64, held for 1 year to earn the full year dividend income, and sold at 5% above the current 200-day SMA. This locks in a much better dividend yield as well, and in addition to a capital gain it generates a total return on capital invested of 13.80%.
This idea assumes the moving average will go in my favor, and of course the risk to this idea is that it does not, thereby creating unrealized losses. However, it creates a general investing framework for thinking about this stock on a longer-term basis rather than trying to time short-term averages and daily movements.
I think if the overheated valuation comes down, we could see more reasonable buying prices on this stock. At the same time, I don't think it will dip too far below its 200-day SMA, so I will stick to that 5% buffer zone.
Ratings Score: Hold/ Neutral
Today, this stock won 3 of my 5 rating categories, earning a neutral/hold rating. This is actually in line with the consensus from both Wall Street as well as the Seeking Alpha quant system, as shown below, which also gave it a hold rating, but is more cautious than the Buy rating consensus from SA analysts.
I think what would make this a buy in my view, as I have already shown, is much lower valuation vs its sector average.
Risks to my Outlook: Earnings Continuing to Beat Estimates
A risk to my neutral/hold outlook is that investors become even more bullish on this stock leading up to and after its next quarterly result this September, thereby making my outlook overly cautious.
Consider, for example, as the chart shows, that this stock either met or beat analyst estimates in all of the four last quarterly earnings. In fact, I think this company could very well achieve a beat on earnings again of between $0.03 and $0.10.
However, my counterargument goes back to the high valuations, and I think that more investors will start to look at the 11x price to book and 26x price to earnings and will start to question if those valuations are really worth it, considering that there are much lower valued opportunities in the financial sector, for example, and some dividend yields over 5%, as I have shown in some recent articles.
So, the risk of continued bullishness on this stock will be offset by valuation-conscious investors, I think. In the comments section, I welcome your feedback on whether you consider a 11x price to book value justified for this company and why or why not?
Analysis Wrap Up
To wrap up, let's review the key points from this analysis:
This stock earned a neutral / hold rating today.
Positives: dividend yield above sector average, net income growth YoY, capital and liquidity strength.
Headwinds: share price high vs 200-day SMA, valuations high vs sector average.
A risk to my neutral outlook is continued investor bullishness on this stock if it beats earnings estimates again.
In closing, I look forward to keeping an eye on this company going forward, particularly what they have going on in terms of innovation and continuous process improvement particularly in the payroll space, which has undergone many changes as changes in technology have taken place and continue to do so going forward.
For further details see:
Paychex: Hold This Innovative Payroll Leader With Positive Net Income Growth