Most fintech stocks have taken a beating in this market, but not all of them. One fintech that has flown under the radar is Paychex (PAYX -0.96%), a company that provides payroll, human resources, and benefits outsourcing services to small and medium-sized businesses.
Paychex has not only generated market-beating returns but also has a strong balance sheet, reduced valuation, good margins, and excellent growth prospects. Let's take a look at why this under-the-radar growth stock is worth considering for your portfolio.
Paychex is a steady grower
Paychex is one of the leading providers of outsourced payroll, benefits, and human resource services, focusing on small companies. It has benefited from the changes accelerated by the COVID-19 pandemic in several different ways, including an increase in the number of employees working remotely and the need for companies to create operational efficiencies by outsourcing these functions. Also, the rise of cloud computing and new technologies have impacted growth.
Paychex has been a steady grower, with earnings rising about 9.6% per year over the last 10 years on an annualized basis through June 22. Annualized earnings growth has been even stronger over the past five years, rising 10.8% per year, and that includes a sharp dip when the pandemic first hit.
Most recently, in its fiscal third quarter ended Feb. 28, Paychex showed that its business is growing even in a down market. In fact, in many ways, it flourishes in a down market as more companies look to outsource these functions, as Chairman and CEO Martin Mucci explained in the earnings report:
While the impacts of COVID-19 are abating, businesses are still operating in a very complex and volatile environment. Focus is shifting from operational and financial survival during the height of the pandemic back to an employee-centric focus, with attracting and retaining talent, remote work, and workplace safety being top areas of concern.
Paychex generated a 15% increase in revenue year over year to $1.26 billion in the quarter, setting a record for new sales revenue. It had a 20% jump in operating income to $562 million and a 23% year-over-year rise in earnings to $1.19 per share. The stock price is down 14% year to date as of June 23 and is up 12% over the past 12 months.
Paychex has some key advantages
Paychex has benefited from macro trends, but its award-winning Paychex Flex technology platform is another key advantage. The cloud-based platform allows companies to handle payroll, HR, and benefits on one site and has helped the company increase sales and retain most of its 710,000 clients. It recently won the best core HR/workforce solution award for small and medium-sized businesses for the third year in a row from Lighthouse Research and Advisory.
The company's financials are also strong, with $1.4 billion in cash and $1.2 billion in operating cash flow. In contrast, it has $885 million in debt and a debt-to-equity ratio of just 0.25. Further, it has a healthy 40% operating margin, and indicative of its operational efficiency, Paychex has a return on equity of 43%.
The company expects to end its fiscal year with revenue up 12% to 13% and earnings per share up 22.5% to 23% compared to the previous fiscal year. The price-to-earnings (P/E) ratio is 31, which is higher than the industry average of roughly 22, but it is down from 35 a year ago and is roughly on par with where it was pre-pandemic.
Paychex has been a solid growth stock for years that has flown under the radar, and it continues to flourish through a tough market for growth stocks. Given the market environment and its key advantages, it should be able to gain market share in the years ahead.
