Paychex Inc. (NASDAQ:PAYX) is in a strong financial position, with no long-term debt on its books. In addition, some analysts believe the company will continue to improve its margins. The quarterly dividend is consistent, and the yield is fairly high. However, it is critical when analyzing Paychex to consider the company's intrinsic value in relation to its price.
In fact, Benjamin Graham, the father of value investing, taught that the most important aspect to consider is whether a company is trading at a discount relative to its intrinsic value. It is through a thorough fundamental analysis that the investor is able to make a determination about a potential investment's merits. Here's a look at how the company fares in the ModernGraham valuation model.
The model is inspired by the teachings of Benjamin Graham and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor or the less conservative Enterprising Investor who is willing to spend a greater amount of time conducting further research.
In addition, Graham strongly suggested that investors avoid speculation in order to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another. By using the ModernGraham method, one can review a company's historical accomplishments and determine an intrinsic value that can be compared across industries.
PAYX data by YCharts
Defensive Investor - Must pass at least 6 of the following 7 tests: Score = 3/7
- Adequate Size of Enterprise - Market capitalization of at least $2 billion - PASS
- Sufficiently Strong Financial Condition - Current ratio greater than 2 - FAIL
- Earnings Stability - Positive earnings per share for at least 10 straight years - PASS
- Dividend Record - Has paid a dividend for at least 10 straight years - PASS
- Earnings Growth - Earnings per share has increased by at least 1/3 over the last 10 years, using 3-year averages at the beginning and end of the period - FAIL
- Moderate PEmg (price over normalized earnings) Ratio - PEmg is less than 20 - FAIL
- 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
- Sufficiently Strong Financial Condition, Part 1 - Current ratio greater than 1.5 - FAIL
- Sufficiently Strong Financial Condition, Part 2 - Debt-to-Net Current Assets ratio less than 1.1 - PASS
- Earnings Stability - Positive earnings per share for at least 5 years - PASS
- Dividend Record - Currently pays a dividend - PASS
- Earnings Growth - EPSmg greater than that 5 years ago - PASS
Valuation Summary
Key Data
| Recent Price | $49.90 |
| MG Value | $22.91 |
| MG Opinion | Overvalued |
| Value Based on 3% Growth | $24.18 |
| Value Based on 0% Growth | $14.17 |
| Market Implied Growth Rate | 10.71% |
| Net Current Asset Value (NCAV) | $1.33 |
| PEmg | 29.93 |
| Current Ratio | 1.11 |
| PB Ratio | 9.73 |
Balance Sheet - February 2015
| Current Assets | $5,957,000,000 |
| Current Liabilities | $5,348,000,000 |
| Total Debt | $0 |
| Total Assets | $7,344,000,000 |
| Intangible Assets | $599,000,000 |
| Total Liabilities | $5,472,000,000 |
| Outstanding Shares | 365,000,000 |
Earnings Per Share
| 2015 (estimate) | $1.81 |
| 2014 | $1.71 |
| 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 |
Earnings Per Share - ModernGraham
| 2015 (estimate) | $1.67 |
| 2014 | $1.57 |
| 2013 | $1.48 |
| 2012 | $1.45 |
| 2011 | $1.42 |
| 2010 | $1.41 |
Dividend History
PAYX Dividend data by YCharts
Conclusion
Paychex passes the initial requirements of the Enterprising Investor but not of the more conservative Defensive Investor. The Defensive Investor is concerned with the low current ratio, the insufficient earnings growth over the last ten years, and the high PEmg and PB ratios. The Enterprising Investor is only concerned by the low current ratio. As a result, all value investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company's intrinsic value.
When it comes to valuation, it is critical to consider the company's earnings history. In this case, the company has seen its EPSmg (normalized earnings) rise from $1.42 in 2011 to only an estimated $1.67 for 2015. This is a weak level of earnings growth, and does not support the market's implied estimate for 10.71% annual growth over the next 7-10 years.
In fact, the recent earnings growth has averaged only 3.49% per year, so the market is expecting a very significant shift in earnings in order to justify the current price. The ModernGraham valuation model returns an estimate of intrinsic value falling below the market's price, indicating that the company is overvalued at the present time.
