Rule #1 Finance Blog

With Investor Phil Town

Your Homework: Paychex, Inc. (PAYX)

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.

Phil