Paychex: Dividend Dynamo or the Next Blowup?

Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.

Let's examine how Paychex (NAS: PAYX) stacks up. In this series, we consider four critical factors investors should examine in every dividend stock. We'll then tie it all together to look at whether Paychex is a dividend dynamo or a disaster in the making.

1. Yield
First and foremost, dividend investors like a large forward yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.

Paychex yields 4%, quite a bit higher than the S&P 500's 2.1%.

2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company paid out in dividends last year to the earnings it generated. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford, even when its dividend yield doesn't seem particularly high.

Paychex has a payout ratio of 84%.

3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The interest coverage ratio indicates whether a company is having trouble meeting its interest payments -- any ratio less than five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Let's see how Paychex stacks up next to its competitors:

Source: S&P Capital IQ.

Payment processing is an extremely capital-light business. Hence the low debt levels for Paychex, ADP, and Global Payment. Fiserv carries a bit more debt because it offers some banking and origination products and services.

4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.

Source: S&P Capital IQ.

Paychex has had a bit of a rougher go of it than other payment processors over the past few years, in large part because small business payroll processing is such a big part of its business. ADP also does HR and payroll processing, but it's more focused on larger companies. Fiserv and Global Payments are more involved in payment processing.

The Foolish bottom line
With a high yield, a high-but-reasonable payout ratio, and zero debt, Paychex looks like a dividend dynamo. Given its moderately high payout ratio, however, dividend investors will want to keep an eye on economic conditions and earnings growth to ensure that the company is able to continue growing its dividend payouts. If you're looking for some other great dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from the Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers -- simply click here.

At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.The Motley Fool owns shares of Fiserv.Motley Fool newsletter serviceshave recommended buying shares of Automatic Data Processing and Paychex.Motley Fool newsletter serviceshave recommended creating a write covered straddle position in Paychex. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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