Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk.  This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company.  By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.  What follows is a specific look at how Paychex Inc. fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Paychex, Inc. is a provider of payroll, human resource, and benefits outsourcing solutions for small to medium-sized businesses. As of May 31, 2012, the Company serviced approximately 567,000 clients, including approximately 2,000 clients through four offices in Germany. The Company offers a portfolio of services and products that allows its clients to meet their diverse payroll and human resource needs. These include payroll processing; payroll tax administration services; employee payment services; regulatory compliance services (new-hire reporting and garnishment processing); Paychex HR Solutions; retirement services administration; insurance services; eServices, and other human resource services and products. In January 2012, the Company acquired Icon Time Systems, Inc. In December 2012, the Company acquired ExpenseWire from Rearden Commerce Inc. In June 2013, Paychex Inc announced that it has acquired HR Services, Inc. and myStaffingPro.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – PASS
- Moderate PEmg ratio – PEmg is less than 20 – FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 4/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – PASS
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – PASS
Valuation Summary
Key Data:
| Recent Price | $41.92 |
| MG Value | $18.40 |
| MG Opinion | Overvalued |
| Value Based on 3% Growth | $22.65 |
| Value Based on 0% Growth | $13.28 |
| Market Implied Growth Rate | 9.17% |
| Net Current Asset Value (NCAV) | $1.20 |
| PEmg | 26.84 |
| Current Ratio | 1.11 |
| PB Ratio | 8.53 |
Balance Sheet – 2/28/2014
| Current Assets | $5,719,300,000 |
| Current Liabilities | $5,138,900,000 |
| Total Debt | $0 |
| Total Assets | $7,069,400,000 |
| Intangible Assets | $580,500,000 |
| Total Liabilities | $5,281,200,000 |
| Outstanding Shares | 363,700,000 |
Earnings Per Share
| 2014 (estimate) | $1.70 |
| 2013 | $1.56 |
| 2012 | $1.51 |
| 2011 | $1.42 |
| 2010 | $1.32 |
| 2009 | $1.48 |
| 2008 | $1.56 |
| 2007 | $1.35 |
| 2006 | $1.22 |
| 2005 | $0.97 |
| 2004 | $0.80 |
| 2003 | $0.78 |
Earnings Per Share – ModernGraham
| 2014 (estimate) | $1.56 |
| 2013 | $1.48 |
| 2012 | $1.45 |
| 2011 | $1.42 |
| 2010 | $1.41 |
| 2009 | $1.41 |
Dividend History
PAYX Dividend data by YCharts
Conclusion:
Paychex Inc. is suitable for the Enterprising Investor but not the Defensive Investor.  The company’s current ratio is too low while the PEmg and PB ratios are too high for the Defensive Investor.  The Enterprising Investor is willing to accept the low current ratio, though, because the company holds no long-term debt.  As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with further research into the company as well as other opportunities, including a review of ModernGraham’s valuation of Automatic Data Processing (ADP) and 5 Undervalued Companies for the Enterprising Investor.  From the valuation side of things, the company appears overvalued after demonstrating very little growth in recent history.  The company’s EPSmg (normalized earnings) have only grown from $1.41 in 2010 to an estimated $1.56 for 2014.  This low level of demonstrated growth does not support the market’s current implied estimate of 9.17% earnings growth and leads the ModernGraham valuation model to return an estimate of intrinsic value that falls well below the market price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects.  What do you think?  What value would you put on Paychex Inc. (PAYX)?  Where do you see the company going in the future?  Is there a company you like better?  Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
If you like our valuations, why not check out ModernGraham Stocks & Screens?  It’s a great way to review the valuations while screening for things like low PE ratio, undervalued companies, etc.!
Disclaimer: Â The author did not hold a position in Paychex Inc. (PAYX) or any of the other companies listed in this article at the time of publication and had no intention of changing that position within the next 72 hours.
Logo taken from wikipedia; this article is not affiliated with the company in any manner.
Leave a Reply