Automatic Data Processing (NASDAQ:ADP) is currently trading in the mid-$90 range with a price-to-earnings ratio of 29.94, a forward P/E ratio of 25.75, and offers a dividend yield of 2.23% with a payout ratio of 60.60%. The five year average P/E ratio for ADP is 23.7, while the broad market's current P/E ratio is 19.3.
Earnings per share for the past twelve months is $3.17, and the EPS growth over the next five years is anticipated to be 10.40%, leveling off to 5.80% thereafter. Using a discount rate of 11% (the stock market average), I estimate fair value for Automatic Data Processing to be $78.37, meaning that the stock is currently overvalued by 21%.
Given its five year average valuation, the opportunities to buy Automatic Data Processing at fair value are few and far between. This is because this business process outsourcing - or BPO - company is the dominant force in its sector. Automatic Data Processing take care of various functions on behalf of many firms globally, such as computing, employee benefits, human resources, payroll, and tax reports.
It has grown from the firm Henry Taub launched in 1949 as Automatic Payrolls, Inc. in Paterson, New Jersey, to a dominant global BPO provider which services 620,000 organizations in over 125 countries, has 90% of Fortune 100 companies - and 80% of Fortune 500 companies - as clients, and currently has a market capitalization of $43.31 billion.
The company is very profitable, with net income between 2011-2015 staying within the parameters of $1.25 billion and $1.5 billion. Furthermore, Automatic Data Processing also boasts a forty-one year streak of paying its shareholders consecutively rising dividends, making the firm a Dividend Aristocrat.
The company benefits from two clear advantages: the fact that payroll and human resources are two areas that they cannot afford to cut costs with, and the size of their operations. Switching the providers of these services can be a costly affair, meaning that such companies will stick with Automatic Data Processing for the long-haul. In addition, no competitor can match the global reach that Automatic Data Processing possesses. The closest U.S. competitor they have is Paychex (NASDAQ:PAYX), and their net income between 2011-2015 was between $548 million and $756.8 million, which is almost half that of Automatic Data Processing for the same period.
It is easy to see why Automatic Data Processing would be an ideal candidate for long-term investors. However, it is clear that Mr. Market agrees, hence its current valuation. And since valuation matters, I cannot recommend the company as a buy at this time, in spite of how excellent it is. A 21% overvaluation is something that cannot be overlooked.
I do recommend keeping an eye on it for a fall in share price, but more patience than usual will be required for this particular stock. As its five-year average P/E ratio suggests, this is not a stock that goes on sale often. Nonetheless, it is one that I reckon will reward such patience in the long-run.
DISCLAIMER: I am not a financial professional and accept no responsibility for any investment decisions a reader makes. This article is presented for information purposes only. Furthermore, the figures cited are the product of the author's own research and may differ from those of other analysts. Always do your own due diligence when researching potential investments.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.