Paychex (NASDAQ: PAYX) has had a strong run in the equity market with a significant 14% increase in its stock in the past three months. We wonder if and what role company financials are playing in this price change, as a company’s long-term fundamentals usually dictate market outcomes. Specifically, we have decided to study the ROE of Paychex in this article.

Return on equity or ROE is a test of how effectively a company increases its value and manages investor money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the shareholders of the company.

Check out our latest analysis for Paychex

How to calculate return on equity?

Return on equity can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

Thus, based on the above formula, Paychex’s ROE is:

37% = US $ 1.1 billion ÷ US $ 2.9 billion (based on the last twelve months to May 2021).

The “return” is the income the business has earned over the past year. This means that for every dollar in shareholders’ equity, the company generated $ 0.37 in profit.

What is the relationship between ROE and profit growth?

So far, we’ve learned that ROE measures how efficiently a business generates profits. Based on how much of those profits the company reinvests or “withholds” and how efficiently it does so, we are then able to assess a company’s profit growth potential. Assuming everything else is equal, companies that have both a higher return on equity and higher profit retention are generally those that have a higher growth rate than companies that do not have the same characteristics.

A side-by-side comparison of Paychex’s 37% profit growth and ROE

First of all, we love that Paychex has an impressive ROE. In addition, the company’s ROE is above the industry average of 17%, which is quite remarkable. This likely paved the way for the modest 7.8% net income growth seen by Paychex over the past five years. growth

The story continues

We then compared Paychex’s net income growth with the industry and found that the company’s growth figure is lower than the industry average growth rate of 14% over the same period, which is a bit disturbing.

Profit growth is an important metric to consider when valuing a stock. It is important for an investor to know whether the market has factored in the expected growth (or decline) in company earnings. This then helps them determine whether the stock is set for a bright or dark future. Is Paychex just valued over other companies? These 3 evaluation measures could help you decide.

Does Paychex effectively reinvest its profits?

The high 80% median payout rate over three years (or a 20% retention rate) for Paychex suggests that the growth of the company has not been really hampered despite the return of most of its revenue to its shareholders.

In addition, Paychex is determined to continue to share its profits with its shareholders, which we can deduce from its long history of paying dividends for at least ten years. Our latest analyst data shows that the company’s future payout ratio over the next three years is expected to be around 71%. As a result, Paychex’s ROE is not expected to change much either, which we have deduced from analysts’ estimate of 38% for future ROE.

Conclusion

Overall, we think Paychex certainly has some positive factors to consider. The company increased its profits moderately, as previously reported. Still, the high ROE could have been even more beneficial for investors if the company had reinvested more of its profits. As noted earlier, the current reinvestment rate appears to be quite low. Looking at current analysts’ estimates, we found that analysts expect the company to continue its recent streak of growth. To learn more about the company’s future earnings growth forecast, take a look at this free analyst forecast report for the company to learn more.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.

Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.