Thursday, October 13, 2005

A Dividend Star Does Some Talking

As I mentioned in the last edition, I am very interested in the dividend hikes of major companies during the fourth quarter. This is a time when many companies make dividend increases based, in part, on what kind of a year they have had, but also, influenced by their expectations for the year ahead. Paychex is a processor of payroll checks and human resources outsourcing for small and medium-sized companies. The company is a solid Dividend Star having raised its dividend for 16 years in a row and has the 4th highest dividend growth among companies that have raised their dividends for at least 10 years in a row. PAYX's dividend growth had slowed to the low double digits over the past 5 years, reflecting the after effects that 9/11 had on employment. However, their business has bounced back, solidly, over the past year in line with US employment growth. Here's the good news. PAYX just announced a 23% dividend hike. That was twice what Value-line was projecting, and 50% more than our own expectations. In our judgment, this larger-than-expected dividend hike is about as important an announcement as we could hope for in this environment. First, as it relates to PAYX, the dividend hike is at a higher rate than their earnings growth for the year and at a much higher growth rate than their hikes of recent years. The only conclusion that makes any sense to me is that they believe their business will continue to improve. Second, and even more importantly, since they are the second largest processor of payroll checks, and the largest processor for small to mid-sized companies, I believe there is a not-too-subtle message that they are bullish on employment in the coming year. This is exactly the kind of "signaling" that I believe companies do all the time with their dividends. In this case, the signal carries over to the the economy as a whole, which is vitally important because of the unknowns created by the hurricanes and the oil spikes. PAYX, it seems to me, is giving us a clear signal that they believe (as we do) that the economy will shake off the ill effects of the storms and grow at about the same rate in 2006 as it has in 2005. As I described earlier in the year, the signaling qualities of companies is a key in our overall analysis of the attractiveness of a company's prospects. Our dividend discount model values PAYX at about $40 per share. With the stock selling at just over $36 per share, it is a reasonable value. It's dividend is not high enough to qualify for our pure dividend style of management, but we do own it in our high growth portfolio. I'll report again when another major company speaks with their money.