Paychex, Inc. (NASDAQ:PAYX) Investors Are Less Pessimistic Than Expected

With a price-to-earnings (or "P/E") ratio of 27x 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 16x and even P/E's lower than 9x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Paychex certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for Paychex

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Paychex.

How Is Paychex's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Paychex's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a worthy increase of 11%. This was backed up an excellent period prior to see EPS up by 54% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 7.7% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 13% per annum, which is noticeably more attractive.

In light of this, it's alarming that Paychex's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Paychex currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Paychex with six simple checks.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.