The jobs report for October came out Nov. 4, and it was a mixed bag. The good
news is the unemployment rate dropped to 9% from 9.1% and August and September
numbers were revised upward by 102,000 jobs. The bad news was only 80,000 jobs
were created in October, missing the 95,000 number expected by economists.
Overall, the economy is showing some signs of recovery, and if it continues, it
will be a boon to companies like ADP (NYSE: ADP ) and Paychex (NASDAQ: PAYX ).
But some are going to benefit more than others, and theres a clear separation
between ADP and PAYX down the road: Latest Earnings Both companies reported
first-quarter earnings in October, but their year-ends are a month apart. ADPs
revenues increased 13% while Paychexs increased 9%, and ADPs earnings increased
8.7% compared to 12.9% for Paychex. For their fiscal years ending in the middle
of 2012, ADP expects profits to grow at least 7% while Paychex sees growth of at
least 5%. So its a toss-up between the two companies in terms of growth. Paychex
appears to be the better company in this instance because its margins are double
ADPs. Paychex can grow at a slightly lesser pace than ADP and still make more
money. Although ADP focuses on medium- to large-sized businesses, whereas
Paychex serves mostly small- and medium-sized businesses, theres enough
similarity in their business models for the margin difference to be meaningful.
Return on Assets Weve already seen that Paychex generates higher margins. Now
well look at how that translates to the balance sheet. Two financial metrics
that stand out are return on assets and cash return on capital invested. Just
because a business has higher margins doesnt guarantee it will have higher
returns on assets and capital invested. Doing a couple of quick calculations, I
see that Paychex does indeed produce superior returns to ADP. Paychexs trailing
12-month return on assets is 10.2%, compared to 3.9% for ADP almost three times
higher. Looking at the cash return on capital invested (or CROCI for short),
Paychexs is 58.9% versus 36.5% for ADP. The same margin of difference holds true
for return on equity. Once again, its clear Paychex makes more with less. This
is always a good thing when deciding where to invest your money. Higher
Dividends The past decade hasnt been great for either stock. ADPs total return
over a 10-year period is 2.3% annually, 100 basis points higher than Paychex
and both of them are underperforming the S&P 500. As of Nov. 4, ADP is up 13.9%
year-to-date compared to -1% for Paychex. ADP is trading less than 7% from its
five-year high, while Paychex is off its five-year high by more than 37%.
Certainly in terms of recent history, Paychex provides greater value. While you
can debate which stock has greater capital appreciation potential, there can be
no debate about dividends. Paychexs current yield is 4.5% compared to 2.8% for
ADP. Stocks create value through dividends, earnings growth and expansion of
valuation multiples. Paychex does a better job than ADP on the dividend front
and about equal in terms of earnings growth. Where Paychex is interesting is in
the contraction in its price-to-earnings ratio over the past decade. Sitting at
60 times earnings in 2001, it now trades at a multiple one-third where it was a
decade earlier. Any bounce-back in the economy will improve profits, and with
it, P/E multiples and stock price. As Jim Cramer stated on a recent Mad Money
episode, "Investors are getting paid to wait." Cramer is, of course, talking
about waiting for the economy to recover. Bottom Line A bet on Paychex is a bet
that small businesses, not larges ones, will be the ones to get us out of this
mess. ADP is backing the wrong horse. As of this writing, Will Ashworth did not
own a position in any of the aforementioned stocks.
No comments:
Post a Comment