Paychex Inc. (PAYX) has increased its dividend every year for the past 19 years. Given the current business and economic outlook can Paychex continue to raise its dividend?
Taken from Yahoo! Finance:
Paychex, Inc., together with its subsidiaries, provides payroll, human resource, and benefits outsourcing solutions for small- to medium-sized businesses in the United States and Germany.
Dividend Growth
To answer this question we need to see if dividend growth has been a function of growth in EPS or has it been due to an increased payout ratio. The table below provides the answer.
During the last 10 years Paychex (PAYX) has grown its dividend at a much faster rate than its EPS. The difference in growth is even more pronounced during the last 5 years. Recently, the majority of Paychex’s dividend growth has come from an expansion of its payout ratio. This high dividend growth is unsustainable. There is a real limit to how much of their earnings companies can payout in the form of a dividend. Paychex is approaching this upper limit.
According to Yahoo! Finance, Paychex’s current dividend-to-earnings payout ratio is 94%. The payout ratio does drop to 81% when compared to free cash flow per share. In order for Paychex to continue to grow its dividend it will need to grow its earnings.
Business Growth
In the payment payroll processing business there are two names that dominate the field, Paychex (PAYX) and Automatic Data Processing (ADP). Automatic Data Processing has focused on large businesses while Paychex has found its niche amongst the small to medium size businesses. Paychex has been very successful in its niche with a 44% market share. The bad news is its growth is tied to small businesses.
Paychex needs small businesses to retain current employees, higher new employees, and grow so that businesses will need Paychex for other services like 401K administration. Given the current economic backdrop is there potential for small businesses to grow meaningfully?
Unless small businesses find a way to grow then Paychex’s growth will be stunted in the short-run. Without real meaningful earnings growth Paychex’s dividend can’t grow. It is already almost paying out a majority of its earnings as dividends and Paychex will have trouble expanding the payout ratio any further.
If the economy does double dip and small businesses are hit even further than Paychex’s dividend will come under pressure.
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