ModernGraham Valuation: Automatic Data Processing (ADP)

moneyCompany Profile (obtained from Google Finance): Automatic Data Processing, Inc. (ADP) is a provider of business outsourcing solutions. ADP offers a wide range of human resource, payroll, tax and benefits administration solutions from a single source. ADP is also a provider of integrated computing solutions to auto, truck, motorcycle, marine, recreational vehicle, and heavy equipment dealers throughout the world. The Company’s operating segments include: Employer Services, professional employer organization (PEO) Services, and Dealer Services. In October 2011, the Company acquired WALLACE – The Training Tax Credit Company. In January 2012, the Company acquired Indian payroll business of Randstad Holding NV. In April 2012, it acquired the human resource solutions subsidiary of SHPS, Inc. In June 2013, Automatic Data Processing, Inc. announced that it has acquired Payroll S.A.

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

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

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

Earnings Per Share – Modern Graham 

2014 (estimate) $2.77
2013 $2.68
2012 $2.59
2011 $2.42
2010 $2.31
2009 $2.20

Conclusion:

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.

What do you think?  Do you agree that Automatic Data Processing overvalued?  Is the company not suitable for either Defensive Investors or Enterprising Investors?  Leave a comment or mention @ModernGraham on Twitter to discuss.

If you like our valuations, why not check out ModernGraham Stocks & Screens?  It’s a great way to review the valuations while screening for things like low PE ratio, undervalued companies, etc.!

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.

Photo Credit:  Andrew Magill


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