Paychex: Payroll and Profits

12/23/2015 8:00 am EST

Focus: STOCKS

Charles Carlson

Editor, DRIP Investor

Our latest featured recommendation provides a variety of payroll, human resource, and benefits-outsourcing services to approximately 590,000 small and medium-sized businesses, explains Chuck Carlson, editor of DRIP Investor.

Paychex (PAYX) has been on a nice roll of late; the stock recently moved to a new 52-week high and is up 17% so far this year, far outpacing the broad market.

Driving the gains have been a number of trends that play to Paychex’s strengths, not the least of which have been continued growth in employment and the specter of rising interest rates.

The company’s bread-and-butter business is payroll-processing services that include calculation, preparation, and delivery of employee payroll checks, tax returns, and collection and remittance of clients’ payroll obligations.

Two important macro factors affect Paychex and those factors are tilting in the company’s favor:

Employment growth—Obviously, the more employees in the system, the better the demand for the company’s services. The good news is employment growth has been improving. In October, total nonfarm payrolls rose 271,000, the fastest growth this year.

Interest rates—Paychex benefits from higher interest rates. The reason is that the company holds lots of client cash that is awaiting remittance to meet client payroll obligations. And Paychex keeps the interest earned on those held funds.

At the end of August, Paychex had more than $3.7 billion in funds held for clients and another $872 million in corporate cash and investments, so the impact of even a moderate increase in interest rates on those funds would be meaningful.

Paychex is coming off a solid fiscal first quarter ended in August. Total revenue rose a respectable 8%, with operating income jumping 11%. For the current fiscal year, per-share profits should rise 10% on a nearly 8% revenue advance.

The stock, trading at 26 times fiscal 2014 earnings estimates of $2.04 per share, is not cheap; still, the combination of above-average top- and bottom-line growth, a nice 3.1% dividend, and a way to play higher interest rates should fuel healthy investor support.

I have owned these shares for years and continue to recommend them for growth-and-income investors.

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