Paychex (NASDAQ:PAYX) Might Become A Compounding Machine

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So, when we ran our eye over Paychex's (NASDAQ:PAYX) trend of ROCE, we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Paychex is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.44 = US$2.1b ÷ (US$12b - US$7.3b) (Based on the trailing twelve months to November 2023).

Therefore, Paychex has an ROCE of 44%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 13%.

Check out our latest analysis for Paychex

Above you can see how the current ROCE for Paychex compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Paychex .

How Are Returns Trending?

It's hard not to be impressed by Paychex's returns on capital. The company has consistently earned 44% for the last five years, and the capital employed within the business has risen 78% in that time. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If Paychex can keep this up, we'd be very optimistic about its future.

On a separate but related note, it's important to know that Paychex has a current liabilities to total assets ratio of 60%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On Paychex's ROCE

In summary, we're delighted to see that Paychex has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. Therefore it's no surprise that shareholders have earned a respectable 74% return if they held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation for PAYX that compares the share price and estimated value.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.