Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing’s for sure: You’ll never discover truly great investments unless you actively look for them. Let’s discuss the ideal qualities of a perfect stock and then decide whether Paychex, Inc. (NASDAQ:PAYX) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it’s certainly a better sign than a stagnant top line.
- Margins. Higher sales mean nothing if a company can’t produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management’s attention. Companies with strong balance sheets don’t have to worry about the distraction of debt.
- Moneymaking opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can’t afford to pay too much for even the best companies. By using normalized figures, you can see how a stock’s simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can’t be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.
With those factors in mind, let’s take a closer look at Paychex.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||2.7%||Fail|
|1-year revenue growth > 12%||4.9%||Fail|
|Margins||Gross margin > 35%||69.9%||Pass|
|Net margin > 15%||24.7%||Pass|
|Balance sheet||Debt to equity < 50%||0%||Pass|
|Current ratio > 1.3||1.10||Fail|
|Opportunities||Return on equity > 15%||34.4%||Pass|
|Valuation||Normalized P/E < 20||22.01||Fail|
|Dividends||Current yield > 2%||4%||Pass|
|5-year dividend growth > 10%||4.8%||Fail|
|Total score||5 out of 10|
Since we looked at Paychex last year, the company has dropped a point, as dividend growth has slowed down. The stock has posted only middling performance, rising between 5% and 10% over the past year.