The jobs report for October came out Nov. 4, and it was a mixed bag. The good news is the unemployment rate dropped to 9% from 9.1% and August and September numbers were revised upward by 102,000 jobs. The bad news was only 80,000 jobs were created in October, missing the 95,000 number expected by economists. Overall, the economy is showing some signs of recovery, and if it continues, it will be a boon to companies like ADP (NYSE:ADP) and Paychex (NASDAQ:PAYX). But some are going to benefit more than others, and there’s a clear separation between ADP and PAYX down the road:
Latest Earnings
Both companies reported first-quarter earnings in October, but their year-ends are a month apart. ADP’s revenues increased 13% while Paychex’s increased 9%, and ADP’s earnings increased 8.7% compared to 12.9% for Paychex. For their fiscal years ending in the middle of 2012, ADP expects profits to grow at least 7% while Paychex sees growth of at least 5%. So it’s a toss-up between the two companies in terms of growth.
Paychex appears to be the better company in this instance because its margins are double ADP’s. Paychex can grow at a slightly lesser pace than ADP and still make more money. Although ADP focuses on medium- to large-sized businesses, whereas Paychex serves mostly small- and medium-sized businesses, there’s enough similarity in their business models for the margin difference to be meaningful.
Return on Assets
We’ve already seen that Paychex generates higher margins. Now we’ll look at how that translates to the balance sheet. Two financial metrics that stand out are return on assets and cash return on capital invested. Just because a business has higher margins doesn’t guarantee it will have higher returns on assets and capital invested. Doing a couple of quick calculations, I see that Paychex does indeed p! roduce s uperior returns to ADP.
Paychex’s trailing 12-month return on assets is 10.2%, compared to 3.9% for ADP — almost three times higher. Looking at the cash return on capital invested (or CROCI for short), Paychex’s is 58.9% versus 36.5% for ADP. The same margin of difference holds true for return on equity. Once again, it’s clear Paychex makes more with less. This is always a good thing when deciding where to invest your money.
Higher Dividends
The past decade hasn’t been great for either stock. ADP’s total return over a 10-year period is 2.3% annually, 100 basis points higher than Paychex — and both of them are underperforming the S&P 500. As of Nov. 4, ADP is up 13.9% year-to-date compared to -1% for Paychex. ADP is trading less than 7% from its five-year high, while Paychex is off its five-year high by more than 37%. Certainly in terms of recent history, Paychex provides greater value.
While you can debate which stock has greater capital appreciation potential, there can be no debate about dividends. Paychex’s current yield is 4.5% compared to 2.8% for ADP. Stocks create value through dividends, earnings growth and expansion of valuation multiples. Paychex does a better job than ADP on the dividend front and about equal in terms of earnings growth.
Where Paychex is interesting is in the contraction in its price-to-earnings ratio over the past decade. Sitting at 60 times earnings in 2001, it now trades at a multiple one-third where it was a decade earlier. Any bounce-back in the economy will improve profits, and with it, P/E multiples and stock price. As Jim Cramer stated on a recent Mad Money episode, ��Investors are getting paid to wait.�� Cramer is, of course, talking about waiting for the economy to recover.
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