Returns On Capital At Paychex (NASDAQ:PAYX) Paint A Concerning Picture

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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 looked at Paychex (NASDAQ:PAYX), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Return On Capital Employed (ROCE): What Is It?

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)

0.43 = US$1.9b ÷ (US$9.2b - US$4.8b) (Based on the trailing twelve months to November 2022).

Therefore, Paychex has an ROCE of 43%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

View our latest analysis for Paychex

In the above chart we have measured Paychex's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Paychex.

What Does the ROCE Trend For Paychex Tell Us?

On the surface, the trend of ROCE at Paychex doesn't inspire confidence. Historically returns on capital were even higher at 56%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Paychex has done well to pay down its current liabilities to 52% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Paychex's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Paychex. Furthermore the stock has climbed 91% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

On a separate note, we've found 1 warning sign for Paychex you'll probably want to know about.

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.