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If you are currently a shareholder in Paychex, Inc. (NASDAQ:PAYX), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. Today we will examine PAYX’s ability to generate cash flows, as well as the level of capital expenditure it is expected to incur over the next couple of years, which will result in how much money goes to you.
What is Paychex's cash yield?
Paychex’s free cash flow (FCF) is the level of cash flow the business generates from its operational activities, after it reinvests in the company as capital expenditure. This type of expense is needed for Paychex to continue to grow, or at least, maintain its current operations.
I will be analysing Paychex’s FCF by looking at its FCF yield and its operating cash flow growth. The yield will tell us whether the stock is generating enough cash to compensate for the risk investors take on by holding a single stock, which I will compare to the market index. The growth will proxy for sustainability levels of this cash generation.
Free Cash Flow = Operating Cash Flows – Net Capital Expenditure
Free Cash Flow Yield = Free Cash Flow / Enterprise Value
where Enterprise Value = Market Capitalisation + Net Debt
Along with a positive operating cash flow, Paychex also generates a positive free cash flow. However, the yield of 4.04% is not sufficient to compensate for the level of risk investors are taking on. This is because Paychex’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
Is Paychex's yield sustainable?
Another important consideration is whether this return is likely to be maintained over the next couple of years. We can gauge this by looking at PAYX’s expected operating cash flows. In the next couple of years, the company is expected to grow its cash from operations at a double-digit rate of 14%, ramping up from its current levels of US$1.3b to US$1.5b in two years’ time. Although this seems impressive, breaking down into year-on-year growth rates, PAYX's operating cash flow growth is expected to decline from a rate of 10% next year, to 3.7% in the following year. But the overall future outlook seems buoyant if PAYX can maintain its levels of capital expenditure as well.
Low free cash flow yield means you are not currently well-compensated for the risk you’re taking on by holding onto Paychex relative to a well-diversified market index. However, the high growth in operating cash flow may change the tides in the future. Now you know to keep cash flows in mind, I suggest you continue to research Paychex to get a more holistic view of the company by looking at:
- Valuation: What is PAYX worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether PAYX is currently mispriced by the market.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Paychex’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.