Did Paychex's Earnings Improve Upon the Signal:Noise Ratio for the General Economy and Stock Market?

Continuing Tuesday's commentary on Paychex as a proxy for the general economy and stock market:

Money Daily may have struck the nail firmly on the head with Tuesday's outlook on Paychex's (PAYX) fiscal fourth quarter (2Q) earnings report. While the company had a small beat, reporting net income of $220.7 million, or 61 cents a share, those figures were down from $230.4 million, or 64 cents a share, in the year-earlier period.

While it may not sound like much, the decline in both revenue and EPS may have shed some significant insight on the overall outlook for July and the third quarter. Paychex deals with millions of small businesses, many likely affected by the shutdowns in April, May, and June, though that data didn't really come through their statement, partly because their quarter included results through May 31 only, leaving June an open question.

There's a strong possibility that Paychex saw more erosion in their customer base in June and that was reflected in their guidance. The company is looking for adjusted EPS to fall six to 10 percent in their fiscal 2021, which actually began June 1.

This is actually significant, and was reflected in Tuesday's trade as the company reported prior to the opening bell. At the close, Paychex was 73.94, -3.84 (-4.94%). At that price, using the last four quarters' EPS of $2.99, the P/E ratio stands at 24.72, making Paychex an overvalued stock (but, which stocks aren't these days?).

Consider the falling revenue and earnings guidance to be an early warning. If the next four quarters come in with a 10% dip in EPS - a distinct possibility - that would put the P/E ratio at an alarming 27.22 (73.94/2.70). In anticipation, the selling was vigorous, with volume close to double the average.

As a proxy for the Main Street economy - because Paychex has so many small and mid-sized business customers - this is a solid sell signal. As earnings decline, so should the share price. Using an EPS of 2.70, figure fair value to call for a P/E around 15, which would put the stock at 40.50 per share, a decline of 45.23%, in line with the general market.

Thus, Paychex is offering a window into July and the third quarter. The stock could just glide along the normal flight path with the market, though the Fed's infinite QE message is beginning to wear thin, but, if Tuesday's five percent knock on Paychex is any kind of signal, the general market may be headed for a deep dive during earnings season, and that's going to heat up significantly beginning next week.

Traders and investors are properly looking to get out of the way of any oncoming steamroller. Paychex is providing a signal to the market, overwhelming the noise from the past two months. This is very likely a tradable event, however, Money Daily is not an investment advisor and has no position in Paychex, at this time. (see full disclaimer below)

Think about it. Who is willing to pay 24 times earnings for a company like Paychex, with a customer base that may be largely going out of business presently or in the near future? A small company with most of its employees laid off or furloughed has little need for a payroll service. With little to no revenue, a company would have diminished need for a tax service like Paychex. A company that closes its doors for good would only need Paychex to do the finalizing paperwork for submission to the IRS or state tax authorities which lays ahead. Such reporting and the lack of an ongoing customer relationship may be as long as a year into the future and not show up readily on Paychex's balance sheet. Keep that in mind. This could play out quickly or be drawn out over many months, but there appears to be a clear case that Paychex's business model may be breaking down as a result of the pandemic, lockdowns, and the obvious, current recession.

Because of the type of business Paychex operates and the unique characteristics of its customer base, there could be quite a bit of downside to their operation. Further, the company may be telling the market to brace for another round of selling, to commence shortly.

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At the Close, Tuesday, July 7, 2020:
Dow: 25,890.18, -396.85 (-1.51%)
NASDAQ: 10,343.89, -89.76 (-0.86%)
S&P 500: 3,145.32, -34.40 (-1.08%)
NYSE: 11,990.13, -169.87 (-1.40%)