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This Stock Could See a Double-Digit Rally Back to Pre-Crisis Levels

Melvin Pasternak

The June jobs report issued July 5 was solidly ahead of expectations. That is good news not only for those seeking work, but also for payroll processors like Paychex (PAYX).

According to the Bureau of Labor and Statistics, 195,000 jobs were created in June. That was more than 25% above the 155,000 economists expected and 7% above the 182,000 monthly average jobs generated during the past 12 months. 

Another piece of good news was that the April and May jobs figures were revised higher by 50,000 and 20,000, respectively. Although the unemployment rate remained steady at 7.6%, it's far lower than the 10% seen near the end of 2009.

With more people working, those companies hiring have additional employee data to process and paychecks to issue. Many companies don't have the HR processing capacity to keep up, so they outsource.

That's where payroll processors like Paychex come in. The company provides payroll services for small- and medium-sized businesses. It issues employee paychecks and processes HR data for more than half a million companies across the U.S.

With more than 100 offices, the company also provides HR administration and compliance, 401(k) plan administration and employee health insurance.

It's also the country's largest provider of retirement record-keeping services, managing 60,000 retirement plans. To expand its retirement services offerings, the company recently began offering access to financial advisors. As baby boomers retire, this segment should help drive future growth.

To solidify growth, the company is also investing in mobile technology and adding health and benefits information to its mobile apps.

The stock is currently trading at a multi-year high.

PAYX Chart

Rising off an August 2011 low near $23, the shares formed a major uptrend line, gaining 68% since then.

After reaching a peak around $34 in September 2012, PAYX retreated to $30.55 by the end of December 2012. However, the stock quickly rose off this low, forming an accelerated uptrend line.

PAYX continued its steady ascent until early May 2013, when it hit a multi-year high of $38.66. However, unable to maintain this peak, shares retreated. Over the remainder of May, the stock pulled back to a low of $36.14, breaking the accelerated uptrend line in the process. A minor downtrend line also formed.

After testing the $36 support level again in June, PAYX has picked up strength during the past three trading weeks. During the first week of July, shares broke the minor downtrend line. In the second week of July, the stock broke through $38.66 resistance, which now is the first level of support.

Shares are now trading at a multi-year high. PAYX has not seen this rarified level since August 2007 when it hit a high near $44 during a strong period of U.S. prosperity and employment. With no near-term resistance, shares could potentially retest those highs.

The bullish technical outlook is backed by strong fundamentals. For the upcoming fiscal first quarter, scheduled to be reported Sept. 23, analysts project an increase in payroll checks will help revenue grow 4.7% to $605.45 million compared to $578.2 million in the year-earlier period. For the full fiscal 2014 year, analysts expect revenue to increase 5.2% to $2.45 billion from $2.33 billion last year.

The earnings outlook is similar. For the fiscal first-quarter, analysts anticipate higher client prices paid will help push earnings up 2.4% to $0.43 per share from $0.42 in the year-earlier quarter. For the full fiscal year, analysts expect a 5.6% rise with earnings reaching $1.69 per share from $1.60 per share last year.

In addition to a strong fundamental outlook, the company has a strong balance sheet with $505.5 million in cash and no long-term debt. This financial strength should give Paychex the freedom to continue developing new technologies that make it easier for clients to use and update payroll information.

PAYX also has an attractive forward annual dividend yield of about 3.6% ($1.40 per share). Due to the company's solid growth outlook, management recently increased the quarterly yield 6%, marking the company's largest quarterly dividend increase since July 2007. The dividend should help cushion any pullback in the share price.

Risks to consider: As more jobs are created and companies hire, there's increased need to outsource payroll and HR data. With an improving economy, demand for Paychex's services should increase, but if hiring contracts again, so too could Paychex's growth.

Recommended Trade Setup:

-- Buy PAYX at the market price
-- Set stop-loss at $35.89, just below important historical support
-- Set initial price target at $44.43 for a potential 13% gain

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