Two important questions to ask before you buy Paychex, Inc. (NASDAQ:PAYX) is, how it makes money and how it spends its cash. This difference directly flows down to how much the stock is worth. Operating in the industry, Paychex is currently valued at US$29b. Today we will examine Paychex’s ability to generate cash flows, as well as the level of capital expenditure it is expected to incur over the next couple of years, which will result in how much money goes to you.
What is free cash flow?
Paychex’s free cash flow (FCF) is the level of cash flow the business generates from its operational activities, after it reinvests in the company as capital expenditure. This type of expense is needed for Paychex to continue to grow, or at least, maintain its current operations.
The two ways to assess whether Paychex’s FCF is sufficient, is to compare the FCF yield to the market index yield, as well as determine whether the top-line operating cash flows will continue to grow.
Free Cash Flow = Operating Cash Flows – Net Capital Expenditure
Free Cash Flow Yield = Free Cash Flow / Enterprise Value
where Enterprise Value = Market Capitalisation + Net Debt
Along with a positive operating cash flow, Paychex also generates a positive free cash flow. However, the yield of 4.04% is not sufficient to compensate for the level of risk investors are taking on. This is because Paychex’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
Does Paychex have a favourable cash flow trend?Does Paychex’s future look brighter in terms of its ability to generate higher operating cash flows? This can be estimated by examining the trend of the company’s operating cash flow moving forward. Over the next two years, Paychex’s operating cash flows is expected to grow by a double-digit 14%, which is encouraging, should capital expenditure levels maintain at an appropriate level. Below is a table of Paychex’s operating cash flow in the past year, as well as the anticipated level going forward.
|Current||+1 year||+2 year|
|Operating Cash Flow (OCF)||US$1.3b||US$1.4b||US$1.5b|
|OCF Growth Year-On-Year||10%||3.7%|
|OCF Growth From Current Year||14%|
Although its positive operating cash flow, and high future growth, is appealing, the low free cash flow yield is unattractive. This is because you would be better compensated in terms of cash yield, by investing in the market index, as well as take on lower diversification risk. However, cash is only one aspect of investing. Keep in mind that cash is only one aspect of investment analysis and there are other important fundamentals to assess. I suggest you continue to research Paychex to get a more holistic view of the company by looking at:
- Valuation: What is PAYX worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether PAYX is currently mispriced by the market.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Paychex’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.