Paychex Stock Underperforms Amid Economic Uncertainty. Can It Recover To Over $140?

Paychex stock (NASDAQ:PAYX) currently trades at $118 per share, around 16% below its level of $141 seen on April 6, 2022 (pre-inflation shock high), and has the potential for gains. In comparison, the company’s peer ADP stock (NASDAQ:ADP) has remained roughly flat over the same period. Paychex saw its stock trading at around $114 at the end of June 2022, just before the Fed started increasing rates, and remains marginally up from these levels. In comparison, the S&P 500 gained about 39% during this period. Paychex stock has benefited from a reasonably stable job market as well as improving operating metrics, including an expanding client base, increased employees per client, and higher per-customer revenue. Paychex also posted a stronger-than-expected set of Q3 FY’24 results, with adjusted earnings coming in at $1.38 per share, up from $1.29 per share a year ago. 

PAYX stock has shown strong gains of 25% from levels of $95 in early January 2021 to around $120 now, vs. an increase of about 40% for the S&P 500 over this roughly 3-year period. However, the increase in PAYX stock has been far from consistent. Returns for the stock were 46% in 2021, -15% in 2022, and 3% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that PAYX underperformed the S&P in 2023.

In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Industrials sector including GE, CAT, and RTX, and even for the mega-cap stars GOOG, TSLA, and MSFT.  In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could PAYX face a similar situation as it did in 2023 and underperform the S&P over the next 12 months – or will it see a strong jump?

Returning to the pre-inflation shock level means that Paychex stock will have to gain about 19% from here. While it’s possible that the stock may recover to those levels, we estimate Paychex valuation to be around $122 per share, only slightly ahead of the market price. This is because of the recent uncertainty about the economy, with growth slowing sharply over the last quarter to 1.6%, amid high interest rates. This could potentially hurt the job market as well, impacting players such as Paychex. Our detailed analysis of Paychex upside post-inflation shock captures trends in the company’s stock during the turbulent market conditions seen over 2022 and compares these trends to the stock’s performance during the 2008 recession.

2022 Inflation Shock

Timeline of Inflation Shock So Far:

• 2020 – early 2021: An increase in money supply to cushion the impact of lockdowns led to high demand for goods; producers were unable to match up.
• Early 2021: Shipping snarls and worker shortages from the coronavirus pandemic continue to hurt the supply
• April 2021: Inflation rates cross 4% and increase rapidly
• Early 2022: Energy and food prices spike due to the Russian invasion of Ukraine. Fed begins its rate hike process
• June 2022: Inflation levels peak at 9% – the highest level in 40 years. The S&P 500 index declined more than 20% from peak levels.
• July – September 2022: Fed hikes interest rates aggressively – resulting in an initial recovery in the S&P 500 followed by another sharp decline
• October 2022: Fed continues rate hike process; improving market sentiments help S&P500 recoup some of its losses.
• Since August 2023: the Fed has kept interest rates unchanged to quell fears of a recession, with rate cuts remaining a strong possibility in 2024.

In contrast, here’s how PAYX stock and the broader market performed during the 2007/2008 crisis.

Timeline of 2007-08 Crisis

• 10/1/2007: Approximate pre-crisis peak in S&P 500 index
• 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
• 3/1/2009: Approximate bottoming out of S&P 500 index
• 12/31/2009: Initial recovery to levels before accelerated decline (around 9/1/2008)

PAYX and S&P 500 Performance During 2007-08 Crisis

PAYX stock declined from nearly $41 in October 2007 (pre-crisis peak) to $22 in March 2009 (as the markets bottomed out), implying that PAYX stock lost almost 46% of its pre-crisis value. It recovered from the 2008 crisis to levels of around $31 in early 2010, rising roughly 41% between March 2009 and January 2010. The S&P 500 Index saw a decline of 51%, falling from levels of 1,540 in September 2007 to 757 in March 2009. It then rallied 48% between March 2009 and January 2010 to reach 1,124.

PAYX Fundamentals Over Recent Years

PAYX revenues have risen from around $4.1 billion in FY’21 to about $5 billion in FY’23, as the company expanded its client base and billings despite the pandemic. Earnings per share rose from $3.06 in 2021 to $4.32 in 2023 as the company’s margins increased with customer retention also picking up. Paychex has a healthy cash position of about $1.7 billion, excluding the funds it holds for clients.

Conclusion

With the Fed’s efforts to tame runaway inflation rates helping market sentiment, we believe Paychex (PAYX) stock has the potential for gains once fears of a potential recession are allayed.

[1] Returns as of 5/30/2024
[2] Cumulative total returns since the end of 2016

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