You Shouldn’t Invest In This Stock
Finding great investment ideas involves using screens, valuation criteria, and fundamental analysis. Value investors are better off using hard criteria like this because it’s easy and it works. I wouldn’t suggest otherwise.
But, there are times when you can and should turn off the screens and invest in companies that might not at first look like attractive investments. Here’s an example of a company that doesn’t look that attractive:
- P/E: 20
- Dividend Growth Rate: none or low single digits.
- Payout Ratio: 80+%
- Business Description: Growth Cyclical.
Not very interesting, right? Most screens would knock this one out for some of these criteria. However, the company also has this criteria:
- No debt.
- Lots of cash on balance sheet.
- Nearly 5% yield.
- Shareholder friendly.
It’s that last one that is most important. Shareholders of Abbott (NYSE:ABT) are finding out what that means because their announced split doesn’t seem to be the best move for the shareholders. That’s the risk, a company could otherwise be great, but the management can bust a move that looks like it will enrich the executives and investment managers at the expense of shareholders.
By the way, the company that I am referring to above is Paychex (NASDAQ:PAYX). Paychex is the largest provider of payroll and human resources services for small and mid-size companies. At this point in the economic cycle it’s evident that growth in payroll is very slow. As a result, Paychex isn’t growing very fast. However, they have manged their business very well and continue to reward the shareholder. They are committed to returning value to the shareholder.
Investing in Paychex now is very contrarian. There are very few people out there who think the economy will grow fast again, much less know how or what will cause such growth to happen. This is like investing in gold in 2001. Or in long term Treasury Bonds in 1999. But when it does happen Paychex will be at the heart of that growth. In the meantime, you can collect the dividend while you wait.
Here’s more about Paychex from Morningstar:
Paychex was formed through the consolidation of 17 payroll processing companies in 1979. It has been one of the most successful human resources outsourcing firms in the United States. The minimal amount of capital required for operations and the firm’s significant competitive advantages have allowed it to produce returns on invested capital that have averaged 70% over the past 10 years. High customer switching costs, inherent scalability, and a respected brand image are the main drivers of the firm’s wide economic moat, and we believe they form a potent combination that will last for some time to come.
Paychex is in excellent financial health, with no debt on its balance sheet. Its ability to generate strong cash flow should keep the company unleveraged.
Paychex also finds itself with a large amount of investable cash, which contributed less than 3% to fiscal 2011 revenue. This investable portfolio of cash, also known as float, is a product of the lag between the time when Paychex receives and pays payroll-related funds on behalf of its clients to employees or other entities. During this lag, the firm is able to invest and earn interest on these funds. However, because of the low interest rate environment and management’s conservative investment strategy, this component of the business has steadily contributed less to overall revenue, and we expect this trend to continue. Given our assumptions, we forecast revenue to slowly improve over the near term and accelerate to a compound annual growth rate of 8% over our seven-year explicit forecast period. This compares with a 9% CAGR over the past seven years. We expect operating margins to range from a low of 38% to a high of 43%, averaging 41%. This compares with average operating margins of 37% over the past seven years.