Paychex’s 21% return over the past six months has outpaced the S&P 500 by 9.3%, and its stock price has climbed to $119.23 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
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Why Is Paychex Not Exciting?
We’re glad investors have benefited from the price increase, but we’re passing on Paychex for now. Here are three reasons why PAYX doesn’t excite us, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance is one signal of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Regrettably, Paychex’s sales grew at a sluggish 9.9% compounded annual growth rate over the last five years. This fell short of our benchmark for the software sector.
2. Projected Revenue Growth Is Slim
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Paychex’s revenue to rise by 5.4%, a deceleration versus its 9.9% annualized growth for the past five years. This projection doesn’t excite us and suggests its products and services will face some demand challenges.
3. Shrinking Operating Margin
Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This metric shows how much revenue remains after accounting for all core expenses — everything from the cost of goods sold to sales and R&D.
Looking at the trend in its profitability, Paychex’s operating margin decreased by 1.1 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 38.6%.
Final Judgment
Paychex isn’t a terrible business, but it isn’t one of our picks. With its shares outperforming the market lately, the stock trades at 6.2× forward price-to-sales (or $119.23 per share). This valuation multiple is fair, but we don’t have much faith in the company. We’re pretty confident there are superior stocks to buy right now. Let us point you toward an all-weather company that owns household favorite Taco Bell.
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