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Here is a look at how Paychex, Inc. (NASDAQ:PAYX) fares in ModernGraham's opinion, based on an updated and modernized version of Benjamin Graham's requirements of defensive and enterprising investors from The Intelligent Investor:

Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?):

Defensive Investor - must pass at least 6 of the following 7 tests: Score = 4/7

  1. Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
  2. Sufficiently Strong Financial Condition - current ratio greater than 2 - FAIL
  3. Earnings Stability - positive earnings per share for at least 10 straight years - PASS
  4. Dividend Record - has paid a dividend for at least 10 straight years - PASS
  5. Earnings Growth - earnings per share has increased by at least 1/3 over the last 10 years using 3-year averages at beginning and end of period - PASS
  6. Moderate PEmg ratio - PEmg is less than 20 - FAIL
  7. Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - FAIL

Enterprising Investor - must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 4/5

  1. Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - FAIL
  2. Sufficiently Strong Financial Condition, Part 2 - Debt to Net Current Assets ratio less than 1.1 - PASS
  3. Earnings Stability - positive earnings per share for at least 5 years - PASS
  4. Dividend Record - currently pays a dividend - PASS
  5. Earnings growth - EPSmg greater than 5 years ago - PASS

Valuation Summary (Explanation of the ModernGraham Valuation Model)

Key Data:

MG Value$17.95
MG OpinionOvervalued
Value Based on 3% Growth$22.50
Value Based on 0% Growth$13.19
Market Implied Growth Rate10.39%
Net Current Asset Value (NCAV)$1.11
PEmg29.27
Current Ratio1.13
PB Ratio9.40

Balance Sheet - 11/30/2013

Current Assets$4,663,800,000
Current Liabilities$4,119,100,000
Total Debt$0
Total Assets$6,019,400,000
Intangible Assets$583,600,000
Total Liabilities$4,259,000,000
Outstanding Shares364,200,000

Earnings Per Share

2014 (estimate)$1.67
2013$1.56
2012$1.51
2011$1.42
2010$1.32
2009$1.48
2008$1.56
2007$1.35
2006$1.22
2005$0.97
2004$0.80
2003$0.78

Earnings Per Share - Modern Graham

2014 (estimate)$1.55
2013$1.48
2012$1.45
2011$1.42
2010$1.41
2009$1.41

Conclusion:

Paychex, Inc. is an interesting company. On the one hand, it has no long-term debt, but on the other hand it has a lot of current liabilities. As a result, the current ratio is relatively poor, but the company still passes the requirements of the Enterprising Investor. The Defensive Investor has a lower risk tolerance, and the company does not pass his requirements due to the poor current ratio as well as high PEmg and PB ratios. Enterprising Investors should feel comfortable proceeding with further research. From a valuation perspective, the company appears to be overvalued at the current time. EPSmg (normalized earnings) have only grown from $1.41 in 2009 to an estimated $1.55 for 2014. This is a very low level of growth that has been achieved in the historical period, and does not support the market's implied growth rate of 10.39%.

Disclaimer: The author did not hold a position in Paychex, Inc. (PAYX) at the time of publication and had no intention of entering into a position within the next 72 hours.

Source: ModernGraham Valuation Of Paychex