ModernGraham Valuation Of Automatic Data Processing

Dec.13.13 | About: Automatic Data (ADP)

Here is a look at how Automatic Data Processing Inc. (NASDAQ:ADP) fares in ModernGraham's opinion, based on an updated and modernized version of Benjamin Graham's requirements of defensive and enterprising investors from The Intelligent Investor:

Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?):

Defensive Investor - must pass at least 6 of the following 7 tests: Score = 4/7

  1. Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
  2. Sufficiently Strong Financial Condition - current ratio greater than 2 - FAIL
  3. Earnings Stability - positive earnings per share for at least 10 straight years - PASS
  4. Dividend Record - has paid a dividend for at least 10 straight years - PASS
  5. Earnings Growth - earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period - PASS
  6. Moderate PEmg ratio - PEmg is less than 20 - FAIL
  7. Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - FAIL

Enterprising Investor - must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5

  1. Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - FAIL
  2. Sufficiently Strong Financial Condition, Part 2 - Debt to Net Current Assets ratio less than 1.1 - FAIL
  3. Earnings Stability - positive earnings per share for at least 5 years - PASS
  4. Dividend Record - currently pays a dividend - PASS
  5. Earnings growth - EPSmg greater than 5 years ago - PASS

Valuation Summary (Explanation of the ModernGraham Valuation Model)

Key Data:

MG Value $40.15
MG Opinion Overvalued
Value Based on 3% Growth $40.17
Value Based on 0% Growth $23.55
Market Implied Growth Rate 9.73%
NCAV -$4.68
PEmg 27.95
Current Ratio 0.96
PB Ratio 6.02
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Balance Sheet - 9/30/2013

Current Assets $21,035,800,000
Current Liabilities $21,899,400,000
Total Debt $14,200,000
Total Assets $29,481,300,000
Intangible Assets $3,734,800,000
Total Liabilities $23,288,500,000
Outstanding Shares 481,800,000
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Earnings Per Share

2014 (estimate) $2.89
2013 $2.80
2012 $2.82
2011 $2.52
2010 $2.40
2009 $2.63
2008 $2.20
2007 $1.83
2006 $1.85
2005 $1.79
2004 $1.56
2003 $1.68
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Earnings Per Share - Modern Graham

2014 (estimate) $2.77
2013 $2.68
2012 $2.59
2011 $2.42
2010 $2.31
2009 $2.20
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Automatic Data Processing fails to qualify for either the Defensive Investor or the Enterprising Investor. The company currently trades at a high PEmg ratio and a high PB ratio, but the most significant issue with the company is the level of current liabilities. Presently, the company has more current liabilities than current assets, leading to disqualification from contention for the Enterprising Investor. While many people claim that the current ratio is not as important today, the fact remains that a company with a strong current ratio is in a better financial position than a company with a poor current ratio. As a result, a poor current ratio indicates increased risk, which Intelligent Investors seek to avoid when possible. We are looking for low-risk, high-reward opportunities, so any increased level of risk makes us wary. As for the valuation, the company has grown EPSmg (normalized earnings) from $2.20 in 2009 to an estimated $2.77 for 2014. This is a very moderate level of growth, and in stark contrast to the 9.73% growth rate implied by the market at this time. Consequently, the market's price is not supported by historical earnings performance and the company appears to be overvalued.

Disclaimer: The author did not hold a position in Automatic Data Processing (ADP) at the time of publication and had no intention of entering into a position within the next 72 hours.