Paychex, Inc. (PAYX): How to Play the Data Processing Sector

Paychex, Inc. (NASDAQ:PAYX), one of the leading providers of payroll services in the United States, specializes in small and medium sized companies and serves almost 600,000 clients. Lately the company has performed well, with solid growth so far during the current fiscal year and strong stock performance. What caught my attention about Paychex was the company’s completely flat revenue numbers for the past five years or so, after incredible growth during the five years before. A quick glance at the revenue chart looks like Paychex, Inc. (NASDAQ:PAYX) ran out of gas once the economy went sour, and it is taking longer to get its mojo back than it has for most other companies. Let’s look a little closer to see if this one is worth owning or if there is a better play in the sector.

About Paychex

Paychex, Inc. (NASDAQ:PAYX) provides a variety of payroll accounting services to its customers including payroll checks, earnings statements, payroll tax returns, and more through their tax filing and employee payment services segments. Additionally, their Human Resources/Professional Employer Organization (HRS/PEO) segment offers employee benefit services, HR services, and more. To combine all of their services, Paychex offers the Paychex Administrative Services (PAS) product, which bundles all of the mentioned services together.

As mentioned, almost all (99%) of Paychex, Inc. (NASDAQ:PAYX)’s client base is made up of small and medium size companies, which is defined by 100 employees or less. Paychex and its share price are very reactive to the national employment rate (more employees = more money spent on payroll services) as well as interest rates, since the company holds funds in its accounts before paying employees or the IRS and those funds earning interest is a very significant source of income for the company.

As optimism has increased about the U.S. employment situation, along with speculation that interest rates may rise sooner rather than later, Paychex, Inc. (NASDAQ:PAYX) has risen to the point where it commands a premium valuation of about 24 times TTM earnings, which strikes me as a bit high considering the company’s so-so history of earnings growth. The consensus of analysts calls for just over 6% annual earnings growth over the next few years, so it doesn’t appear to me that the high multiple is justified.