Is This Stock a Buy over the Fiscal Cliff?

Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Investors often need to ask themselves why they hold certain stocks and then ask themselves whether that is what the market wants to buy. After which they then need to decide what the market will want in the future and whether that stock will perform as expected. In the case of Paychex (NASDAQ: PAYX) I think the proposition is pretty clear. It is a dividend play, but I’m intrigued by its potential for short term upside. Let me explain.

Paychex Writes You a Check

Essentially we are in a slow growth, low interest rate environment right now and, as long as we are, investors will seek out relatively high dividend yielding stocks with better-than-GDP growth prospects. Paychex currently yields 4.2% and has single digit earnings growth rates forecast for the next couple of years at least.  Moreover, its end markets are relatively correlated with jobs growth and the economic cycle. You will get a decent and slowly growing dividend pay check out of Paychex. You will also get some upside going forward from the potential for small business formulation to increase within a growing economy.

So is that it? Is it time to stop writing, let readers make their own minds up and then get back to watching the markets or the mighty Arsenal thrash their next opponent? Yes and no.

Yes because I think the yield plus the growth kicker is really the reason for buying the stock. No because I think there is some short term upside here.

Slow Macro Environment

A quick look at how Paychex generated revenues in the last quarter.

<img src="/media/images/user_12882/paychex1_1_large.png" />

The revenue split tells only part of the story. Payroll service only grew by a derisory 1% while Human Resource Services grew at 12%. I wouldn’t get too excited about revenues generated from client funds because interest rates don’t appear to be going up anytime soon.

The real question is over payroll services growth. The key metric here is the checks per payroll number, and this grew by a lowly 1.2% in the quarter from 1.8% growth last year. Indeed, the company was internally disappointed with payroll services revenue. The problem appears to be that the economy is not improving as it had expected, or rather that worries over the ‘fiscal cliff’ issue have damaged small business confidence.  I suspect the latter.

Here is the small business job openings data from the National Federation of Independent Business (NFIB), and there is a graphical case for a slowdown caused by the uncertainty of budgetary standoffs.

<img src="/media/images/user_12882/paychex2_2_large.png" />

Naturally, when companies report disappointing numbers in their core business, investors will be keen to know if this is a macro issue or whether Paychex is losing market share to Automatic Data Processing (NASDAQ: ADP) or Insperity (NYSE: NSP). Indeed, PAYX’s management spent a lot of time on the last earnings conference call assuring analysts that the slow growth was really a macro issue.  As for ADP and NSP, they have both been reporting similar sluggishness in the economy, so I wouldn’t get too despondent over PAYX just yet. Where competition does have an effect is on the ability of PAYX to raise pricing and this seems endemic across the industry.

In fact if you share my opinion over the fiscal cliff issue then this could be a decent buying opportunity. Short term, I’m not worried about the standoff. The posturing will be resolved and the game will go on again. The problem is more of a long term one, and the only US politician I would trust to reduce the deficit is Ron Paul; but then I’m not an American so my opinion doesn’t matter.

Guidance and Expectations

Longer term, PAYX is looking for the economy to help it get back to high single digit revenue growth, but for this year it is looking for 2-3% in payroll service growth and 9-11% in human resources revenue. Overall service revenue is forecast at 5-6%, but there could be upside to this number if events play out as I suspect. This makes PAYX a decent punt on a resolution to the fiscal cliff debacle. I’m assuming that there is some pent up demand for new business formulation being created by the ongoing political debate.

In conclusion, in the near term there is a bit more to PAYX than its yield, and investors may well want to take a closer look.


SaintGermain has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Automatic Data Processing and Paychex. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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