Paychex Stumbles, Now Overvalued

 | Jun 28, 2013 | 8:22 AM EDT
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Paychex (PAYX) was the biggest loser Thursday among the 500 stocks in the Standard & Poor's 500 Index, down 3.7% on a day when more than 80% of stocks were up.

That broke a pattern of success. Going into June, the stock was up five months in a row. Through Wednesday, it was up 22% for the year.

I don't think Thursday's medicine was the last dose. I think Paychex will underperform the market for the rest of this year.

Paychex earnings for the fourth fiscal quarter came in at 34 cents a share. That was the same as last year's fourth quarter, and at least three cents a share below what analysts were expecting.

For the fiscal year that ended in May, Paychex total earnings were up 4% and earnings per share were up 3%. Those are not the growth rates that dreams are made of. They are about as sexy as a used bar of soap.

For fiscal 2014, CEO Efrain Rivera told investors to expect an 8% to 9% gain in earnings in 2014. Clearly that wasn't enough to satisfy growth-hungry traders.

A stock that's cheap can afford to report flat or disappointing earnings. But Paychex fans don't expect such things. The stock is priced on the expectation of continuing success. Consider:

  • In a market priced at 16x earnings, Paychex goes for 23 x earnings.
  • While the average stock fetches 2.3x book value (corporate net worth per share), Paychex trades at 7.4x book.
  • Compared with the average stock at 1.5x revenue, Paychex commands 5.7x revenue.

With such valuations, Paychex should be delivering above-average growth. Instead, it is delivering mediocre results. I look for further hits in the months ahead.

With more than half a million clients, Paychex is the second-largest payroll processing company in the U.S., after Automatic Data Processing (ADP). Both are good companies -- highly profitable, with sterling balance sheets.

But both have seen a reduction in growth rates lately, as employers are being highly cautious about adding new employees to payrolls. Neither is an attractive stock to me right now. I think payrolls will recover over the next 18 months, but investors have already priced that in..

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