Yahoo Finance Declining Stock and Solid Fundamentals: Is The Market Wrong About Paychex, Inc. (NASDAQ:PAYX)?
Paychex (NASDAQ:PAYX) has had a rough month with its share price down 3.0%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Paychex's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Paychex
How To Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Paychex is:
46% = US$1.6b ÷ US$3.5b (Based on the trailing twelve months to November 2023).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.46 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Paychex's Earnings Growth And 46% ROE
Firstly, we acknowledge that Paychex has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. This likely paved the way for the modest 10% net income growth seen by Paychex over the past five years.
Next, on comparing Paychex's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 11% over the last few years.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is PAYX worth today? The intrinsic value infographic in our free research report helps visualize whether PAYX is currently mispriced by the market.
Is Paychex Making Efficient Use Of Its Profits?
While Paychex has a three-year median payout ratio of 76% (which means it retains 24% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Moreover, Paychex is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 75%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 44%.
Conclusion
In total, we are pretty happy with Paychex's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
