Updated on April 18th, 2024 by Bob Ciura
Automatic Data Processing (ADP) might not be a household name, but it should be for dividend growth investors. ADP has raised its dividend each year for 49 years in a row.
ADP is a member of the Dividend Aristocrats, a group of 68 stocks in the S&P 500 Index with 25+ years of consecutive dividend increases. ADP has one of the longest streaks of dividend increases among the Dividend Aristocrats.
We have created a full list of all 68 Dividend Aristocrats, along with important metrics like P/E ratios and dividend yields, which you can download by clicking on the link below:
Disclaimer: Sure Dividend is not affiliated with S&P Global in any way. S&P Global owns and maintains The Dividend Aristocrats Index. The information in this article and downloadable spreadsheet is based on Sure Dividend’s own review, summary, and analysis of the S&P 500 Dividend Aristocrats ETF (NOBL) and other sources, and is meant to help individual investors better understand this ETF and the index upon which it is based. None of the information in this article or spreadsheet is official data from S&P Global. Consult S&P Global for official information.
ADP’s long history of dividend growth is the result of a strong business model and durable competitive advantages. This has led to domination of its core markets for decades. To quote legendary investor Warren Buffett, ADP has a wide economic moat.
This article will review ADP’s fundamentals and discuss whether the stock is trading at an attractive enough valuation to buy now.
Business Overview
ADP is a business outsourcing services company. It was founded in 1949 and began with a single client. In the 75 years since ADP has grown into the leading payroll and human resource outsourcing company. It has over 1 million clients in more than 140 countries worldwide.
ADP provides services to companies of all sizes, including payroll, benefits administration, and human resources management. ADP enjoys high demand for these services, as companies would prefer to outsource these functions in order to better focus on their core business activities.
Source: Investor Presentation
ADP has a leading position across its strategic pillars, as well as a highly diversified client list.
The company has undergone significant restructuring in recent years. In 2014, ADP spun off its human capital management business, which now trades as CDK Global (CDK).
ADP posted fiscal second-quarter earnings on January 31st, 2024, and results were quite strong. Adjusted earnings-per-share came to $2.13, which was three cents ahead of estimates, and up 9% year-over-year. Net earnings were up 8% to $878 million. Revenue was up 6.4% year-over-year to $4.67 billion, and $10 million ahead of estimates. The company saw organic constant-currency revenue rise 6%.
Interest on funds held for clients rose 20% year-over-year to $225 million, as market rates remain high relative to recent history. Average client funds balances declined 2% to $32.6 billion year-over-year, while the yield on those funds expanded by 50 basis points to 2.8%.
Growth Prospects
Automatic Data Processing has compounded its adjusted earnings-per-share at a rate of more than 11% per year over the last decade, which we believe it can come close to matching moving forward.
Beyond 2023, we believe the company is capable of delivering 9% annualized growth in earnings-per-share over full economic cycles. Much of this growth is likely to be driven by the company’s Professional Employer Organization (PEO) Services segment, which continues to deliver strong growth.
Importantly, this revenue growth has been accompanied by meaningful margin expansion, which means that the segment’s growth has had an outsized impact on the firm’s bottom line.
In addition, share buybacks are a low single-digit tailwind to annual EPS growth, and we expect that will continue moving forward.
ADP credits its large and growing HCM market as a major growth catalyst in the next several years.
Source: Investor Presentation
Two key long-term growth catalysts for ADP are continued payroll increases and expanding regulations.
The number of employees on ADP clients’ payrolls continues to grow, and we believe this will continue for the foreseeable future. Next, the increasingly complex regulatory environment creates significant compliance costs for businesses; this also helps provide ADP with long-term growth.
Competitive Advantages & Recession Performance
Many competitive advantages fuel ADP’s growth. ADP has a deep connection with its customers and enjoys a strong reputation for customer service, which helps keep customer retention very high.
ADP enjoys a tremendous scale that its competitors cannot match. As a global company, ADP is uniquely positioned to help companies with employees on multiple continents.
In addition, ADP benefits from a recession-resistant business model. ADP’s earnings-per-share during the Great Recession are shown below:
- 2007 earnings-per-share of $1.83
- 2008 earnings-per-share of $2.20 (20% increase)
- 2009 earnings-per-share of $2.39 (8.6% increase)
- 2010 earnings-per-share of $2.39 (flat)
ADP increased earnings-per-share in 2008 and 2009, which is a rare accomplishment. The reason for ADP’s continued growth during the Great Recession is that businesses still need payroll and human resource services, even in an economic downturn.
The company continued to perform relatively well in the 2020 economic downturn caused by the coronavirus pandemic. ADP remained highly profitable during the pandemic, which allowed it to maintain its streak of annual dividend increases.
The necessary nature of ADP’s services helps insulate the company from the effects of a recession. Given ADP’s size and scale, we believe it will perform well during the next recession.
Valuation & Expected Returns
We forecast adjusted earnings-per-share of approximately $9.15 for fiscal 2024. Based on the current share price of ~$242, the stock has a price-to-earnings ratio of 26.4.
We see fair value for ADP at 29 times earnings, meaning the stock appears to be undervalued. This implies a small tailwind to total returns in the coming years from valuation expansion.
If the P/E multiple expands from 26.4 to 29 over the next five years, it would boost annual returns by 1.9% per year.
We expect ADP to grow earnings-per-share by 9% annually over the next five years. In addition, the stock has a current dividend yield of 2.3%.
The combination of earnings growth, dividends, and valuation expansion results in a total expected return of 13.2% per year over the next five years.
ADP will almost certainly continue to increase its dividend for many years to come, given that its fundamentals are so strong. ADP maintains a target payout ratio of 55%-60% of annual earnings, so the payout is very safe with room to grow.
Final Thoughts
ADP is a strong business. The company maintains a large list of customers and holds a top position in the industry. This gives it a wide economic “moat”, a term popularized by investing legend Warren Buffett.
Indeed, ADP’s wide moat keeps competitors at bay, leading to high profitability levels.
There should be plenty of growth going forward, both in terms of earnings and dividends. Regulations continue to become more complex.
And, as the economy expands, companies are adding employees and increasingly use ADP’s services. If a recession occurs, ADP should continue to increase its dividend, as customers will still need its services.
With an expected rate of return above 13%, we rate ADP stock a buy.
If you are interested in finding high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:
- The Dividend Achievers List: a group of stocks with 10+ years of consecutive dividend increases.
- The Dividend Kings List: considered to be the best-of-the-best among dividend growth stocks, the Dividend Kings are a group of exceptional dividend stocks with 50+ years of consecutive dividend increases.
- The Blue Chip Stocks List: contains stocks on either the Dividend Achievers, Dividend Aristocrats, or Dividend Kings list.
- The Monthly Dividend Stocks List: contains stocks that pay dividends each month, for 12 payments per year.
- The High Dividend Stocks List: high dividend stocks are suited for investors that need income now (as opposed to growth later) by listing stocks with 5%+ dividend yields.
The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly: