Paychex, Inc. (PAYX): Safe 3.5% Dividend Yield, No Debt, and Excellent Business Consistency

Looking at longer-term trends in payout ratios provides additional perspective. As seen below, PAYX’s payout ratios have increased from about 50% in 2005 to 70-80% today. This means that dividend growth outpaced earnings growth, which is not sustainable. Overall, the company’s higher payout ratios mean that future dividend growth will need to be driven by earnings growth.

Source: Simply Safe Dividends

Source: Simply Safe Dividends

While PAYX’s payout ratios are higher than we like, the business is very stable. During the financial crisis, we can see that the company’s sales actually grew by 1% in 2009 and only fell by 4% in 2010. The stock also outperformed the S&P 500 by 12% in 2008. Business customers lay off employees during tough economic times, but they still require PAYX’s mission-critical services.

Source: Simply Safe Dividends

Since PAYX primarily delivers its services over the internet, it operates with low fixed cost. The company’s scale leverages these costs and allows PAYX to earn very strong returns on invested capital – signs of an economic moat.

Source: Simply Safe Dividends

Not surprisingly, PAYX throws off substantial free cash flow each year. With a client retention rate in excess of 80%, the company has great visibility.

Source: Simply Safe Dividends

Finally, PAYX’s balance sheet is in excellent condition. The company has no debt and over $900 million in cash and investments. The company has plenty of flexibility to acquire complementary products, return more cash to shareholders, and reinvest for growth.

All things considered, PAYX’s 3.5% dividend yield appears to be very safe. While the company’s payout ratio is higher than we like to see, this risk is mitigated by PAYX’s predictable cash flows and pristine balance sheet.