Paychex, Inc.'s (NASDAQ:PAYX) Recent Stock Performance Looks Decent- Can Strong Fundamentals Be the Reason?

Most readers would already know that Paychex's (NASDAQ:PAYX) stock increased by 4.4% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Paychex's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Paychex

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Paychex is:

44% = US$1.7b ÷ US$3.8b (Based on the trailing twelve months to May 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.44 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Paychex's Earnings Growth And 44% ROE

First thing first, we like that Paychex has an impressive ROE. Secondly, even when compared to the industry average of 16% the company's ROE is quite impressive. Probably as a result of this, Paychex was able to see a decent net income growth of 11% over the last five years.

As a next step, we compared Paychex's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 9.9% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is PAYX worth today? The intrinsic value infographic in our free research report helps visualize whether PAYX is currently mispriced by the market.

Is Paychex Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 76% (or a retention ratio of 24%) for Paychex suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, Paychex has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 78%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 42%.

Conclusion

On the whole, we feel that Paychex's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.