A Stock That Has Regular Paydays

07/31/2008 12:00 am EST

Focus: STOCKS

Charles Carlson

Editor, DRIP Investor

Charles Carlson, editor of the DRIP Investor, finds a stock that has set records for 18 years in a row.

Paychex (Nasdaq: PAYX) is facing a number of headwinds these days. The company, a leading payroll-processing and human-resources company, benefits from a strong employment market. Thus, when employment numbers are down, that usually pressures the stock.

Another factor that hurts profits is a low-interest-rate environment. Indeed, by virtue of its tax-paying services for companies, at any point Paychex holds billions of dollars for customers. Paychex earns interest on those funds being held for tax payments. Thus, when short-term rates are low, the income from these holdings suffers.

To give you an idea of the magnitude of these holdings and the importance of short-term rates, Paychex held $3.7 billion in funds for clients at the end of May, up from $3.6 billion in the [same period a year ago].

However, because the average interest rate earned on these funds during the quarter was 3.1%—down from 4% in the previous year—interest on funds held actually declined 15% in the May period.

Despite this decline in interest income, Paychex managed to show a 19% increase in per-share earnings in the fiscal fourth quarter ending in May. For fiscal 2008 [as a whole,] Paychex posted a 16% increase in per-share earnings. Total revenue increased 10% to $2 billion. Fiscal 2008 represented the 18th consecutive year of record revenues, net income, and earnings per share.

Paychex’s forecast for fiscal 2009 seems rather conservative. The company expects net income to increase 2% to 4%. The firm expects continued pressure on its interest income in fiscal 2009.

Trying to guess where interest rates will be 12 months from now is difficult. However, it is entirely possible that if the economy can find its footing, the Federal Reserve Board may feel it has the cover it needs to raise interest rates to fend off inflationary pressures. Higher rates would be a plus for Paychex and its bottom line.

Thus, if you are looking for a way to hedge against higher interest rates, Paychex offers an interesting option. [At around $33 Wednesday,] Paychex trades at 20x the consensus earnings estimate for fiscal 2009 of $1.64 per share. That price-earnings multiple is not dirt cheap, but is reasonable for a company sporting a strong track record of growth. Enhancing appeal is the stock’s current yield of 3.8%. The company pays a quarterly dividend of 31 cents per share.

Finally, Paychex offers a user-friendly dividend reinvestment plan (DRIP). The plan permits initial purchases directly with a minimum $250. Subsequent investments are a minimum $100. There is no enrollment fee and no purchase fees.

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