Is Paychex Destined for Greatness?

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Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Paychex fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Paychex's story, and we'll be grading the quality of that story in several ways:

  • Growth: are profits, margins, and free cash flow all increasing?
  • Valuation: is share price growing in line with earnings per share?
  • Opportunities: is return on equity increasing while debt to equity declines?
  • Dividends: are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Paychex's key statistics:


PAYX Total Return Price Chart

PAYX Total Return Price data by YCharts.

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

14.6%

Fail

Improving profit margin

10.4%

Pass

Free cash flow growth > Net income growth

16.1% vs. 19.7%

Fail

Improving EPS

18.9%

Pass

Stock growth (+ 15%) < EPS growth

43.1% vs. 18.9%

Fail

Source: YCharts. *Period begins at end of Q1 (Feb.) 2010.

PAYX Return on Equity Chart

PAYX Return on Equity data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

0.2%

Pass

Declining debt to equity

No debt

Pass

Dividend growth > 25%

112.9%

Pass

Free cash flow payout ratio < 50%

91.3% 

Fail

Source: YCharts. *Period begins at end of Q1 (Feb.) 2010.

How we got here and where we're going
Paychex's five out of nine passing grades are a little disappointing considering its rather solid position in the American employment chain. However, these results do reflect the anemic nature of America's recovery, as Paychex seems to be only barely ahead of inflation (these are three-year metrics, after all). What does the future hold for Paychex as it struggles to grow in a difficult jobs market against several muscular payroll-processing competitors?

Paychex's quarterly report -- scheduled for tomorrow -- should shed more light on its progress. The company's small- and mid-sized business target market is getting increasingly crowded. Automatic Data Processing pushes in from above (it typically works with larger companies) with the option to deposit paychecks into a prepaid Visa card. Intuit , maker of TurboTax and other small-business software, is pushing up from below with cloud-based payroll software that allows really small businesses to manage employee paychecks with a greater degree of control.

Paychex is fighting back through diversification, as it recently bought an HR staffing software-as-a-service company to improve its human resource options. That's more likely to fend off ADP than Intuit, which is targeted toward companies that have perhaps a half-dozen or fewer employees. That may not be enough to justify continued investor optimism in the company -- Fool contributor Rich Smith, while analyzing ADP, discovered that Paychex has the slowest historical growth rate and the lowest anticipated forward growth rate of the pack.

Putting the pieces together
Today, Paychex has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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Keep track of Paychex by adding it to your free stock Watchlist.

The article Is Paychex Destined for Greatness? originally appeared on Fool.com.

Fool contributor Alex Planes has no position in any stocks mentioned. The Motley Fool recommends Automatic Data Processing, Intuit, and Paychex. The Motley Fool owns shares of Intuit. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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