U.S. Key stock Paychex earned record profits again in the year to May 31. Its profits are expected to set new records this year and next. While they’re costly, the shares remain a buy for attractive and growing dividends while you wait for long-term share price gains.
Rochester, New York-based Paychex, a business and consumer services stock, has come back stronger than ever since the recession of 2008 and 2009. It has earned record profits for three years in a row. The company is expected to earn record profits this year and next. It’ll use its earnings and cash flow to reinvest in the business, raise its dividends and buy back shares. The shares are costly. Even so, Paychex remains a buy for attractive and growing dividends while you wait for further long-term share price gains.
Paychex got its start doing payrolls for small- and medium-sized businesses. It began fiscal 2018 (on June 1) with 605,000 payroll clients. The company notes that it pays one out of a dozen Americans in the private sector. It has expanded to also offer retirement, insurance and human resources services.
In the year to May 31, Paychex earned a record $799 million, or $2.20 a share, excluding one-time items from both periods. This was up by 8.4 per cent from $736 million, or $2.03 a share, the year before.
President and chief executive officer Martin Mucci said: “Fiscal 2017 was another year of solid growth in revenue and earnings. Our business model remains strong [with] industry-leading margins.”
Growing earnings, dividends and share buybacks
Paychex has just raised its dividend to two dollars a share. That yields an attractive 3.5 per cent. Mr. Mucci said: “The dividend increase continues the company’s history of providing outstanding shareholder value.” Dividend increases look sustainable. That’s because Paychex remains debt free and has cash and corporate investments of $777 million.
Paychex also rewards its shareholders with share buybacks. In fiscal 2017, it spent $166 million to repurchase 2.9 million shares. By the beginning of fiscal 2018, the number of shares outstanding had fallen by one million, to 359.4 million.
Paychex’s better earnings are confirmed by a 7.3 per cent rise in its fiscal 2017 cash flow to $1.065 billion. This comfortably exceeded investment of $103 million and dividends of $662 million.
In its outlook for fiscal 2018, Paychex expects its earnings to rise by seven to eight per cent. This year, Paychex is expected to earn $2.37 a share. This would represent earnings per share growth of 7.7 per cent. Based on this estimate, the shares trade at a hefty price-to-earnings, or P/E, ratio of 24.1 times. The MGI (Marpep Growth Index) of 0.4 suggests that the shares are somewhat overvalued. Next year, Paychex’s earnings are expected to advance by 7.2 per cent, to $2.54 a share. Based on this estimate, the shares trade at a better, but still hefty, P/E ratio of 22.5 times.
Paychex will continue to grow
Paychex expects to continue to grow. It writes that its cash, cash flow “and available short-term financing, will support our normal business operations, capital purchases, business acquisitions, share repurchases and dividend payments for the foreseeable future”. The company may seek to expand abroad to, for instance, Germany. This would reduce its exposure to the U.S. economy.
The consensus recommendation of 15 analysts is ‘Hold’. While Paychex is costly, we see it as a ‘Buy’.
This is an edited version of an article that was originally published for subscribers in the July 28, 2017, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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