With a price-to-earnings (or "P/E") ratio of 30.3x Paychex, Inc. (NASDAQ:PAYX) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 19x and even P/E's lower than 11x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
While the market has experienced earnings growth lately, Paychex's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.
View our latest analysis for Paychex
How Is Paychex's Growth Trending?
Paychex's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 1.9%. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 19% in total. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 11% per annum during the coming three years according to the analysts following the company. That's shaping up to be similar to the 11% per annum growth forecast for the broader market.
With this information, we find it interesting that Paychex is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Bottom Line On Paychex's P/E
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
Our examination of Paychex's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
Having said that, be aware Paychex is showing 3 warning signs in our investment analysis, you should know about.
If these risks are making you reconsider your opinion on Paychex, explore our interactive list of high quality stocks to get an idea of what else is out there.
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