Paychex, Inc. (NASDAQ:PAYX) Is Yielding 2.8% - But Is It A Buy?

Simply Wall St

Is Paychex, Inc. (NASDAQ:PAYX) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

A slim 2.8% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Paychex could have potential. The company also bought back stock during the year, equivalent to approximately 0.5% of the company's market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

NasdaqGS:PAYX Historical Dividend Yield, February 18th 2020

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Paychex paid out 81% of its profit as dividends. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Paychex paid out 71% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's positive to see that Paychex's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

We update our data on Paychex every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. Paychex has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$1.24 in 2010, compared to US$2.48 last year. Dividends per share have grown at approximately 7.2% per year over this time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. It's good to see Paychex has been growing its earnings per share at 12% a year over the past five years. Earnings per share are growing nicely, but the company is paying out most of its earnings as dividends. This might be sustainable, but we wonder why Paychex is not retaining those earnings to reinvest in growth.

Conclusion

To summarise, shareholders should always check that Paychex's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Paychex's is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Overall we think Paychex is an interesting dividend stock, although it could be better.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 16 Paychex analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.

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. Thank you for reading.