Has Paychex Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock and then decide whether Paychex fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Moneymaking opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Paychex.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

2.7%

Fail

 

1-year revenue growth > 12%

4.9%

Fail

Margins

Gross margin > 35%

69.9%

Pass

 

Net margin > 15%

24.7%

Pass

Balance sheet

Debt to equity < 50%

0%

Pass

 

Current ratio > 1.3

1.10

Fail

Opportunities

Return on equity > 15%

34.4%

Pass

Valuation

Normalized P/E < 20

22.01

Fail

Dividends

Current yield > 2%

4%

Pass

 

5-year dividend growth > 10%

4.8%

Fail

       
 

Total score

 

5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Paychex last year, the company has dropped a point, as dividend growth has slowed down. The stock has posted only middling performance, rising between 5% and 10% over the past year.

Paychex is one of the leading providers of HR and payroll services to employers, focusing on small and mid-sized businesses for its primary client base. You might think that given the weak economic environment and tepid job growth in recent year, Paychex would have struggled, especially in comparison to rival Automatic Data Processing and its focus on healthier large employers. But throughout the years, the company has countered slow organic growth by making strategic acquisitions to build up its payroll, retirement benefits, and other HR segments. It also makes the most of the revenue it gets, with industry-leading profit margins that dwarf ADP's.

But the HR industry has made major advances in the recent past, with the rise of LinkedIn changing the ground rules for the business. So far, LinkedIn has stayed on the staffing and recruiting side of the business, but if it attracts enough premium clients among employers, it'll be a natural fit for LinkedIn to expand its services and go after Paychex's core payroll business.

Paychex could get a boost from new tax laws, as the resolution to the fiscal cliff crisis resulted in changes to withholding for taxes, certain retirement benefits, and other payroll-handling issues. The company will have to fend off Intuit , however, which will inevitably use its reputation for tax expertise to try to boost its position in the payroll-handling industry.

For Paychex to improve, it needs to find the growth that should naturally result from better employment figures. The recovery has been slow, but if job creation speeds up, Paychex could get a lot closer to perfection.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

Click here to add Paychex to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

The article Has Paychex Become the Perfect Stock? originally appeared on Fool.com.

Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Automatic Data Processing, Intuit, LinkedIn, and Paychex and owns shares of Intuit and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

Learn about investing from the comfort of your own home.

Portfolio Basics

Take the first steps to building your portfolio.

View Course »

Investment Strategies

Learn the strategies you need to build a winning portfolio

View Course »

Add a Comment

*0 / 3000 Character Maximum