Cover Image for Your Homework: Paychex, Inc. (PAYX)

Your Homework: Paychex, Inc. (PAYX)

Phil Town
Phil Town

We haven't done a homework evaluation in a while, so here's a quick one on Paychex, Inc. (PAYX).

Phil, I heard you speak in Memphis this year, read your book, and have been doing research and practicing since then. I'm having trouble finding a wonderful company on sale. PAYX is a possibility, strong company, market leader, no debt, numbers look good. I understand the business and like their plan for future growth.

Using a conservative growth rate of 14% and current PE of 28% it looks like PAYX is pretty close to sticker. At the avg. PE of 48 it's just a little above MOS. I would appreciate your feedback if you take a look at this company.

Thanks for showing me the way.

Darwin Martin

My response:

Hi Darwin,

I do like these guys.  They went through a bump and are over it.  I think the avg analyst rating rounded off is conservative at 16%.

With a 32 PE I get PAYX at $44 selling for $39.  I've been following these guys for a while so I feel okay about buying in when it gets out of the 20% red zone (20% below Sticker up to Sticker), so below $36 it's buyable.  If you are new to this business, get a bigger MOS.  $22 would be nice, but not likely.

Let's talk about the valuing PAYX for a second.  You'll notice that they used to grow EPS and BVPS consistently at over 25%. 

Sales ran from 20% up and Cash ran around 20%. 

Then everything came down. 

That, of course, created the buying opportunity.  In 2002 the stock was selling for $22 down from a high of $60. 

But how would we have valued it then?  Would we use 7% as the long term growth rate?  Not if we understood the business, we wouldn't.  I used a 22% growth rate and a 44 PE on the TTM EPS of $0.60 to get a Sticker of $48 in 2002 when it was selling for $22. MOS was $24 for me, so it was buyable. 

Today the rules make me lower the growth rate a bit, which I'm happy with since BVPS, cash and sales are all hovering around 16%.  Buying opportunites come along and that's when the homework pays off.  You know what has 3 of the 4 Ms and you wait for that big MOS and then load up the truck.

The result for PAYX is about 100% in 4 years if you just held it.  Not bad at 18% compounded.   If you get in and out like me, you did even better.

Speaking of which, given a requirement for buying at under $36, the last entry opportunity was in August as it came off the $33 bottom.  In at $35, out at $39.  And now it's priced about right. 

Which brings up an interesting question: Is "about right" okay to buy? 

I think Charlie Munger (Buffett's partner) said something like "It's better to buy a wonderful business at a fair price than a fair business at a wonderful price," perhaps unintentionally making the collateral point that it is tough to find a big MOS on a great business.  Especially when you are trying to invest $30 billion.  Easier with $50 thousand, I do believe.

But Charlie makes a good point: if you buy a great business when it's fairly priced, like PAYX is now, you should do well.  It should continue to grow your money at something above 15%, which as we all know, is enough to get very rich. 

So why not follow Charlie's lead and do it? 

Well, for one reason, because Charlie isn't buying PAYX.  Which means that he doesn't think it's a wonderful business at a fair price. Since it's obviously a wonderful business, Charlie and Warren must think it's not such a '"fair" price. 

Which is the reason I do the whole MOS thing.  I do it simply because I am not Warren or Charlie and I need to have a big cushion against a big goof.   Be patient.  Spend your time building your watch list with great businesses you really do understand.  The opportunity will come and you will be ready with the cash.

Now go play.