Paychex: The Big Business of Small Business

09/08/2020 5:00 am EST

Focus: TECHNOLOGY

Stephen Mauzy

Income-Investing Specialist, Wyatt Investment Research

The United States is home to over 30 million small businesses employing 57% of the U.S. workforce, observes Stephen Mauzy, growth and income expert and editor of Wyatt Research's Personal Wealth Advisor.

Paychex (NPAYX) provides services that every new and small business will demand once it gains traction. It is a leading provider of payroll processing, human resources, and benefits services to small business around the country and around Europe. 

Paychex takes a smaller-is-better view of the world. Small business dominates its clientele. Roughly 99% of Paychex’s clients are businesses composed of 100-or-fewer employees. The average client size of the business is approximately 16 employees.

I love its business. Paychex is divided into two primary segments — payroll services (55% of revenue) and human resources services (45%). Paychex handles the mundane administrative paperwork entrepreneurs hate to handle.

Small business is, indeed, big business. It is also a growth business. Paychex reported fiscal-year 2020 (ended in May) revenue of $4.04 billion. Annual revenue has doubled over the past 10 years. It has grown at an average 7% annual rate

Of course, we are all aware that 2020 is the year of the asterisk because it is the year of the pandemic. In Paychex’s case, most of the pandemic-induced damaged will be concentrated in the first quarter of this fiscal year (June through August).

As we progress through this calendar year (and fiscal year), Paychex’s business should improve. Management expects to report incremental improvement with each successive quarter. Pre-coronavirus norms should return by the further quarter (March through May 2021) of fiscal-year 2021.  

Paychex’s competitors are few and far between. Barriers to entry are high. A lot of infrastructure is required to efficiently process and price payroll and HR services.

Once Paychex lands a customer, few leave the fold. The cost, in both time and money, to switch is prohibitive for most businesses. Should the clouds linger longer than I expect, it’s still all good. The balance sheet remains as solid as ever.

My $90 price target is based on a 28 multiple, the growth multiple investors have historically applied, to expectations for $3.20 of earnings heading into fiscal-year 2022 (which is only nine months away).

The return potential is further enhanced by a generous dividend that yields 3.2%. (By the way, the dividend grows annually.) I am expecting at least a 20% total return over the next 12 months.

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