Paychex (PAYX)

Payroll and human resources software provider, Paychex (NASDAQ:PAYX) met Wall Street’s revenue expectations in Q1 CY2025, with sales up 4.8% year on year to $1.51 billion. Its non-GAAP profit of $1.49 per share was 0.7% above analysts’ consensus estimates.

Company Overview

One of the oldest service providers in the industry, Paychex (NASDAQ:PAYX) offers its customers payroll and HR software solutions.

Modern HR software has two powerful benefits: cost savings and ease of use. For cost savings, businesses large and small much prefer the flexibility of cloud-based, web-browser-delivered software paid for on a subscription basis rather than the hassle and complexity of purchasing and managing on-premise enterprise software. On the usability side, the consumerization of business software creates seamless experiences whereby multiple standalone processes like payroll processing and compliance are aggregated into a single, easy-to-use platform.

Reviewing a company’s long-term sales performance reveals insights into its quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Unfortunately, Paychex’s 6.6% annualized revenue growth over the last three years was weak. This fell short of our benchmark for the software sector and is a tough starting point for our analysis.

This quarter, Paychex grew its revenue by 4.8% year on year, and its $1.51 billion of revenue was in line with Wall Street’s estimates.

Looking ahead, sell-side analysts expect revenue to grow 6.8% over the next 12 months, similar to its three-year rate. This projection doesn't excite us and suggests its newer products and services will not accelerate its top-line performance yet.

For software companies like Paychex, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.

Paychex’s gross margin is better than the broader software industry and signals it has solid unit economics and competitive products. As you can see below, it averaged a decent 72% gross margin over the last year. That means for every $100 in revenue, roughly $72.03 was left to spend on selling, marketing, and R&D.

Paychex produced a 74.3% gross profit margin in Q1, in line with the same quarter last year. On a wider time horizon, the company’s full-year margin has remained steady over the past four quarters, suggesting its input costs have been stable and it isn’t under pressure to lower prices.

Paychex has been a well-oiled machine over the last year. It demonstrated elite profitability for a software business, boasting an average operating margin of 41.5%.

Analyzing the trend in its profitability, Paychex’s operating margin might fluctuated slightly but has generally stayed the same over the last year. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability.

In Q1, Paychex generated an operating profit margin of 45.8%, in line with the same quarter last year. This indicates the company’s cost structure has recently been stable.

Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can’t use accounting profits to pay the bills.

Paychex has shown terrific cash profitability, enabling it to reinvest, return capital to investors, and stay ahead of the competition while maintaining an ample cushion. The company’s free cash flow margin was among the best in the software sector, averaging 29.5% over the last year.

Paychex’s free cash flow clocked in at $667.3 million in Q1, equivalent to a 44.2% margin. This cash profitability was in line with the comparable period last year and above its one-year average.

Over the next year, analysts predict Paychex’s cash conversion will improve. Their consensus estimates imply its free cash flow margin of 29.5% for the last 12 months will increase to 37.3%, it options for capital deployment (investments, share buybacks, etc.).

One of the best ways to mitigate bankruptcy risk is to hold more cash than debt.

Paychex is a profitable, well-capitalized company with $1.6 billion of cash and $863.7 million of debt on its balance sheet. This $737.3 million net cash position gives it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here.

There weren't many resounding positives in these results. Both revenue and EBITDA were roughly in line with expectations. The stock traded down 1.1% to $142.52 immediately following the results.

Updated: May 21, 2025 at 10:17 PM EDT

The latest quarterly earnings matters, sure, but we actually think longer-term fundamentals and valuation matter more. Investors should consider all these pieces before deciding whether or not to invest in Paychex.

Paychex has some positive attributes, but it isn’t one of our picks. Although its revenue growth was weak over the last three years, its impressive operating margins show it has a highly efficient business model.

Paychex’s price-to-sales ratio based on the next 12 months is 9.7x. Investors with a higher risk tolerance might like the company, but we think the potential downside is too great. We're pretty confident there are superior stocks to buy right now.

Wall Street analysts have a consensus one-year price target of $144.96 on the company (compared to the current share price of $156.20).

Want to invest in a High Quality big tech company? We’d point you in the direction of Microsoft and Google, which have durable competitive moats and strong fundamentals, factors that are large determinants of long-term market outperformance.

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