Paychex Stock Looks Overvalued

PAYX: Paychex logo

The shares of Paychex (NASDAQ: PAYX) and  Automatic Data Processing (NASDAQ: ADP) have surpassed pre-pandemic levels assisted by a recovering economy and lowering unemployment figures. Currently, the market is pricing Paychex stock at a slightly higher trailing P/E multiple of 41 compared to 38 for ADP. Does that make Paychex stock an expensive pick? Comparing a slew of factors such as historical revenue growth, returns, and risk, Trefis believes that the market seems to be too optimistic on Paychex stock. Our earlier article, What Is Driving The Rally In Paychex Stock?, highlights the key reasons for the recent momentum in PAYX. While historical growth figures of Paychex have been better than ADP, both companies are likely to observe similar topline expansion in FY2022. Being the market leader, Trefis believes that ADP stock is a better pick over Paychex. Our dashboard Paychex vs Automatic Data Processing: Industry Peers; Which Stock Is A Better Bet? details the fuller picture, parts of which are summarized below.

1. Revenue Growth

Paychex’s growth has been stronger than ADP over the last couple of years, with its revenues expanding at an average rate of 8.6% per year from $3.2 billion in FY2017 to $4.1 billion in FY2021, versus ADP’s revenues which grew by 5% per year from $12.4 billion in FY2017 to $15 billion in FY2021.

  • ADP is the industry leader in payroll processing business with almost a 16% market share in the U.S. Thus, its business growth depends on macroeconomic factors such as GDP, employment statistics, wages, etc.
  • Paychex’s growth has been driven by a rising client base and consistent improvement in customer retention percentage. The company’s total client base increased by 17% from 605,000 in 2017 to 710,000 in 2021 – assisting demand for management solutions and professional employer organization services. Notably, the company caters to around 8.8% of the total 8 million employer firms in the U.S.
  • Both companies categorize their services into two parts, Management Solution (Employer Services) and Professional Employer Organization. Management Solutions segment provides key human capital management services including payroll processing, tax administration, HR solutions, and retirement services. The PEO (professional employer organization) is a comprehensive employment administration solution where employees working for a client are co-employed by Paychex and the client (known as worksite employees).
  • Employer Services and Professional Employer Organization segments contribute 70% and 30% of total revenues for both companies, respectively.
Relevant Articles
  1. Paychex Stock Underperforms Amid Economic Uncertainty. Can It Recover To Over $140?
  2. Can Paychex Stock Recover To Its Pre-Inflation Shock Highs?
  3. Can Paychex Stock Recover To Its Pre-Inflation Shock Highs?
  4. With The Job Market Holding Up, What To Expect From Paychex Q2 Results?
  5. What To Expect From Paychex Q1 Results
  6. What’s Happening With Paychex Stock?

2. Returns (Profits)

Coming to Returns, both companies have been providing consistent returns to investors as dividends and share repurchases. However, ADP has a lower operating margin compared to Paychex, leading to lower operating cash flow and net margins.

  • In FY2021, ADP reported an operating margin and net income margin of 22% and 17%, respectively. The company generated $3 billion of operating cash on revenues of $15 billion. Subsequently, it invested $178 million in property, plant & equipment, repurchased $1.4 billion of common stock, and paid $1.6 billion in dividends.
  • Whereas, Paychex reported 36.3% of operating margin and 27% of net income margin in FY2021. The operating cash margin stood at 36% as non-cash expenses were low. With $1.2 billion of operating cash, the company incurred $114 million of capital expenses, repurchased $155 million of common stock, and paid $908 million in dividends.
  • Both companies return more than three-quarters of their operating cash to shareholders.

3. Risk

As neither of the two companies have considerable net debt, technological disruption and competitive rivalry are key risks to their earnings. From the perspective of financial leverage, both companies are fairly comparable.

  • In FY2021, ADP reported $3 billion of long-term debt and $2.5 billion of cash & cash equivalents on the balance sheet.
  • Similarly, Paychex reported $800 million of long-term debt and $995 million of cash & cash equivalents on the balance sheet.
  • As the market leader, ADP processes one in six American payrolls. Thus, betting on the industry leader will provide consistent returns as topline growth depends on macroeconomic factors.

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