Over the past six months, Paychex’s stock price fell to $100.59. Shareholders have lost 11.3% of their capital, which is disappointing considering the S&P 500 has climbed by 10.9%. This might have investors contemplating their next move.
Is there a buying opportunity in Paychex, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Is Paychex Not Exciting?
Even with the cheaper entry price, we’re sitting this one out for now. Here are three reasons you should be careful with PAYX, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
Examining a company’s long-term performance can provide clues about its quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Over the last five years, Paychex grew its sales at a sluggish 9.9% compounded annual growth rate. 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 6.9%, 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 see some demand headwinds.
3. Shrinking Operating Margin
While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.
Looking at the trend in its profitability, Paychex’s operating margin decreased by 4.6 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 36.9%.
Final Judgment
Paychex isn’t a terrible business, but it doesn’t pass our quality test. Following the recent decline, the stock trades at 5.4× forward price-to-sales (or $100.59 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We’re pretty confident there are superior stocks to buy right now. We’d recommend looking at an all-weather company that owns household favorite Taco Bell.
Stocks We Would Buy Instead of Paychex
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