Outlook on Paychex (PAYX) - Good Companies, Not Always Good Investments

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Paychex is set to report tomorrow with many investors wondering if they will beat estimates. When taking a closer look at Paychex, it is quite impressive how they have continued to improve their Economic Margin (EM). EM’s for Paychex went from 10 in 1994 to roughly 30 in 2007.

*AFG’s Value Expectations allows us to understand the Sales Growth, EBITDA Margin, and Asset Turnover a company has to deliver in the future to justify its current trading price. In theory, and in normal circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The table displays the implied future Sales Growth of Apple assuming its EBITDA Margins and Asset Turnover stays at the 3 year median levels.

However, good companies don’t always make good investments.  By using their 5yr median EBITDA Margins (40.81% ) and asset turns (.31) then solving for the sales growth that is priced in, at $26.16  investors are paying Paychex to grow their sales by 15.58% over the next five years.  Considering sell side estimates for 2009 are expected to be .05%, they have a huge hill to climb.

Source (Applied Finance Group)

What do we use to measure corporate performance and calculate an intrinsic value:
AFG’s Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital. Our Economic Margin Framework encompasses a valuation system that explicitly addresses the four main value drivers of enterprise value: profitability, competition, growth, and cost of capital.