As a dividend growth investor, I try to identify companies that can show growth throughout all portions of the economic cycle. Companies that can minimize the negative impact of a recession and quickly pivot to growth during a recovery are the names I want in my portfolio.
These companies tend to be best of breed in their industry and often have a respectable dividend growth history.
One name that fits this description is Paychex, Inc. (NASDAQ:PAYX), which provides business services to more than 700,000 small- and medium-sized companies. This article will examine why I believe Paychex to be one of the most consistent companies in the market.
Earnings Results
Paychex reported fourth quarter and full year earnings results on June 26th, 2024.
For the quarter, revenue grew 5.3% to $1.30 billion while adjusted earnings-per-share of $1.12 compared favorably to $0.97 in the prior year. Both results were ahead of what analysts had expected. For the fiscal year, revenue was up 5% to $5.3 billion. Adjusted earnings-per-share of $4.72 improved more than 10% from $4.27 in fiscal year 2023.
Both segments within the company posted gains for the quarter. Management Solutions, the larger of the two businesses, grew 3% to $930.3 million while PEO and Insurance Solutions was up 9% to $326.6 million.
Management Solutions growth was caused by an increase in client base and higher product penetration for HR and retirement services. PEO and Insurance Solutions grew due a higher number of worksite employees and improvements in insurance revenue.
Management provided initial guidance for fiscal year 2025, with revenue projected to be up 4% to 5.5% and earnings-per-share expected to be higher by 5% to 7%.
Earnings Takeaways: A Model of Consistency
Paychex delivered beats on both the top- and bottom-line in the most recent quarter, but this is nothing new to the followers of the name. The company has managed to beat earnings-per-share forecasts every quarter since at least the first quarter of fiscal year 2020. Revenue has disappointed either with results having topped estimates in 18 of the last 20 quarters.
Paychex consistently delivers better than expected results.
The company’s earnings-per-share growth typically runs ahead of its revenue growth. For example, fourth quarter and fiscal year revenue were both up ~5%, but earnings were higher by a double-digit amount.
This is not unusual for the company either. Over the last decade, as the business environment has generally been conducive to lower unemployment, earnings growth has a compound annual growth rate of 11%. By comparison, Paychex’s revenue has a CAGR of 7.6% during this time. Much of these gains have come since fiscal 2020, as earnings-per-share are up 57% overall during that period.
Importantly, bottom-line growth is not the work of financial engineering via share repurchases. In fact, the share count has remained nearly unchanged since 2014.
Growth in earnings-per-share has come from improving margins. All margins have increased over the last decade, but none more so than Paychex’s net margin, which has expanded 740 basis points to 32% in fiscal year 2024.
As a company that is greatly tied to the health of the economy and to the job market, it might be expected that Paychex does poorly in an economic downturn, but this has not been the case.
During the Great Recession, Paychex performed better than most. Revenue increased each year of the period while earnings-per-share fell just 1.3%.
More recently, the company grew earnings-per-share during the worst of the Covid-19 pandemic. The company’s fiscal years do not match up with calendar year 2020, but earnings growth was achieved in the periods that did. Paychex had growth of 5.6% and 1.3% in fiscal years 2020 and 2021, respectively.
In a vacuum, this growth during the pandemic is not extraordinary, but considering the massive unemployment that was caused from social distancing restriction and the layoffs that occurred makes the results that much more impressive.
In my opinion, the most attractive feature of Paychex is that the company navigates periods of high unemployment very well, seeing, at its worst, just a small pullback in earnings-per-share. Then in times of lower unemployment and economic expansion, the company see high rates of growth.
Management’s guidance for fiscal year 2025 implies just 6% earnings-per-share growth in fiscal year 2025, which is obviously not to the level that investors have been accustomed. It should be noted that earnings-per-share are starting from a relatively high base due to the high growth that the company has experienced in the medium-term. Mid-single-digit growth could be the normal for the company.
That is what analysts expect.
Still, a mid-single-digit growth rate coupled with Paychex’s performance during periods of high unemployment coupled with its track record during economic expansions should make the name an attractive investment on that basis alone.
Dividend and Valuation Analysis
But there is more to like about Paychex then just its business model and past results.
Paychex yields 3.3% as of Friday’s close, more than double the average yield of the S&P 500 Index. This is also a favorable yield compared to the stock’s five-year average yield of 2.7%.
The company has a solid track of raising the dividend, including a 10.1% increase for the payment made in May. This is slightly higher than the five-year average increase of 9.8%. Dividend growth tends to deaccelerate as the payments increase in size, but Paychex does not appear to be at that point yet.
And that is with an elevated payout ratio. The projected payout for the fiscal year is 78%, which is just under the 80% level that the company has averaged over the last 10 years.
Paychex can raise its dividend at nearly a double-digit annual rate because the company’s performance remains on track largely regardless of what is happening with the economy. This helps to alleviate some of the concern that comes with a high payout ratio.
Shares of Paychex are trading at 23.6 times expected earnings-per-share for the fiscal year. This compares to the average price-to-earnings ratios of 28.8 for the past five years and 27 for the last 10 years.
My price-to-earnings ratio range for Paychex is 26 to 28, which I believe balances the company’s long-term performance and valuations. Applying expected earnings-per-share to this range leads to a price target range of $129 to $139. Therefore, returns could be in a range of 9.7% to 18.3% from the most recent closing price. Add in the stock’s yield, and total returns could be in the low double-digits at the very least.
Final Thoughts
Paychex once again delivered quarterly results that were above what was expected, much has it done in its recent history. The company has consistently produced growth, or at the very least managed to cap declines, even against some of the worst economic backdrops this century.
Furthermore, the company ramps up its growth when market conditions turn favorable, providing investors a best of both world’s scenario. A company that can limit damage or even grow during a recession and then demonstrate accelerated growth during economic expansion can prove to be an excellent investment.
This is especially true if the company offers an attractive yield and raises its dividend at a healthy rate.
This is what Paychex has accomplished over time. Earnings growth has outpaced revenue growth, which has led to double-digit dividend increases.
In my opinion, the company's combination of a strong business model, the ability to withstand economic downturns, yield, and dividend growth earn Paychex a buy recommendation.