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Steady Payout From Paychex

This wide-moat firm provides a high-quality opportunity for investors.

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 Paychex (PAYX) is among the best businesses we cover. The firm has produced returns on invested capital that have averaged well above 70% during the last 15 years, with the triumvirate of high customer switching costs, solid scale advantages, and a respected brand image providing a wide economic moat. We believe the stock is currently undervalued, giving investors an opportunity to gain a powerful return from a top-tier business.

Paychex faced some harsh headwinds during the recent recession, which slowed its usually stellar performance and sent its stock reeling. The stock price has since recovered from trough levels, and we believe there is still more upside. During the recent recovery, poor new business formation and disappointing new client sales execution hampered the pace of recovery for the payroll processor. These factors disappointed many market participants and have held Paychex's stock from recovering more robustly. The firm's equity currently trades at about 80% of our fair value estimate; combining this with a healthy 4% dividend yield gives investors an excellent potential return. We believe the confluence of a moderately recovering employment market, more robust new business starts, and a retooled salesforce will provide a strong catalyst for further stock price appreciation.

Vishnu Lekraj does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.