Resiliency during downturn has Paychex in enviable position

Paychex (Nasdaq: PAYX), recently reporting another solid quarter, continues to cash in on cutting checks for the employees of hundreds of thousands of companies.

While revenue increased slightly and operating income surged, the number of employees Paychex serves grew modestly year over year. The fact that the company can continue holding onto clients in this environment, and even pick up new ones, testifies to the company’s strength.

Paychex’s staying power is important because roughly two-thirds of its business comes from payroll service, which depends largely on the number of businesses it contracts with and the number of employees those businesses have. The company wasn’t forced to offer more generous terms to retain clients, either. Days sales outstanding, a measure that compares growth in accounts receivable to revenue growth, declined considerably on a year-over-year basis, signaling improving profit margins. Paychex’s margins are much stronger than bigger competitor Automatic Data Processing.

Once employment starts to pick up, Paychex should start to grow considerably. But given the company’s strong performance even now, and the stock’s 3.9 percent dividend yield, it might be a good idea to pick up shares while things still seem bad. (Paychex is a “Motley Fool Inside Value” pick and the Fool owns shares of it. Automatic Data Processing is a “Motley Fool Income Investor” selection.)

Ask the Fool

Q: I see that Citigroup is planning to “reverse-split” its stock soon. What does that mean, and is it a good thing? – N.J., Columbia, Mo.

A: Reverse splits are often executed by companies that have been or are in trouble. Whereas a typical stock split results in your owning more shares of a company at a lower price (with no change in the overall value of your shares), a reverse split leaves you with fewer shares at a higher price.

Imagine owning 100 shares of Citigroup, recently trading near $5 per share. The total value of your shares is $500. After the 1-for-10 reverse split in early May, you’ll have one share for every 10 that you owned, leaving you with 10 shares. But their value will increase proportionately, to around $50 per share. So your total value remains … $500.

Regular stock splits are nothing to get excited about, but a reverse split is a red flag. The company may be trying to prop up its share price so that it doesn’t look like a penny stock. Citigroup has been getting its act together following its stock-price implosion during the recent credit crisis, but it’s not completely out of the woods yet.

Interestingly, since Citigroup is one of the most heavily traded stocks, this will have an effect on overall stock market volume, as measured by the number of shares traded. Sensible long-term investors shouldn’t care much about market volume, but those who do watch it may see it drop by 10 percent or more due to this split.

Q: How can a stock be “oversold”? – M.C., Strasburg, Va.

A: That term suggests too many people have been selling it, giving it a lower-than-deserved share price.

My dumbest investment

When I was working at Worldcom, it was quite common for employees to have 100 percent of their retirement accounts in the company’s stock. While I think it adds incentive to perform if employees have a stake in the company they work for, in the case of Worldcom, most people lost everything, including their jobs.

I managed to get out before the bottom but lost most of what I had, and eventually got laid off, too. Now my investments are a lot more diverse. – S.L., Sharpsburg, Ga.

The Fool responds: Ouch. It does seem logical to be heavily invested in your employer. After all, you probably know it a lot better than you know any other company. But remember that it already provides almost all your income, via your salary. So by putting your retirement money in it, too, you’ve got a heck of a lot of eggs in that one basket.

It’s hard to imagine large, well-known companies going belly up, but they sometimes do. Worldcom filed for bankruptcy protection in 2002, with more than $100 billion in assets.