Automatic Data Processing (ADP) has shown some earnings growth over the last few years and pays a healthy dividend, which may garner some attention from prospective investors. In fact, many analysts who focus on dividend growth investing have the company on the radar as a potential investment, including Safe Dividend Stocks, Dividend Ladder, and Integrator. While dividend growth potential is a great qualitative item to utilize when making an investment decision, it is critical to first conduct a quantitative analysis of the company.
Benjamin Graham, the father of value investing, taught that the most important aspect to consider is whether the company is trading at a discount relative to its intrinsic value. It is through a thorough fundamental analysis that the investor is able to make a determination about a potential investment’s merits.
The model is inspired by the teachings of Benjamin Graham and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor or the less conservative Enterprising Investor, who is willing to spend a greater amount of time conducting further research.
In addition, Graham strongly suggested that investors avoid speculation in order to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another. By using the ModernGraham method, one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.
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Defensive Investor – Must pass at least 6 of the following 7 tests: Score = 3/7
- Adequate Size of Enterprise – Market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – Current ratio greater than 2 – FAIL
- Earnings Stability – Positive earnings per share for at least 10 straight years – PASS
- Dividend Record – Has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – Earnings per share has increased by at least one-third over the last 10 years, using three-year averages at the beginning and end of the period – FAIL
- Moderate PEmg (price over normalized earnings) Ratio – PEmg is less than 20 – FAIL
- 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 to be suitable for a Defensive Investor: Score = 4/5
- Sufficiently Strong Financial Condition, Part 1 – Current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt-to-Net Current Assets ratio less than 1.1 – PASS
- Earnings Stability – Positive earnings per share for at least 5 years – PASS
- Dividend Record – Currently pays a dividend – PASS
- Earnings Growth – EPSmg greater than that 5 years ago – PASS
|Value Based on 3% Growth||$42.48|
|Value Based on 0% Growth||$24.90|
|Market Implied Growth Rate||10.22%|
Balance Sheet – March 2015
Earnings Per Share
Earnings Per Share – ModernGraham
Automatic Data Processing is not very attractive when compared to some other companies in the Business Support industry. For example, aModernGraham valuation of Robert Half Incorporated (NYSE:RHI) indicates that company is suitable for the Enterprising Investor and fairly valued at the present time. On the other hand, Paychex Inc. (NASDAQ:PAYX) was found to be suitable for Enterprising Investors but significantly overvalued in its most recent ModernGraham valuation.
Automatic Data Processing passes the initial requirements of the Enterprising Investor but not the Defensive Investor. Specifically, the Defensive Investor is concerned by the low current ratio, insufficient earnings growth over the last ten years, and the high PEmg and PB ratios while the Enterprising Investor is only concerned by the low current ratio. As a result, all Enterprising Investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.
When it comes to that valuation, it is critical to consider the company’s earnings history. In this case, it has grown its EPSmg (normalized earnings) from $2.45 in 2011 to an estimated $2.93 for 2015. This level of demonstrated growth does not support the market’s implied estimate for annual earnings growth of 10.22% over the next 7-10 years.
In recent years, the company’s actual growth in EPSmg has averaged around 3.9% annually, but the ModernGraham valuation model reduces the actual growth to a more conservative figure when making an estimate, and returns an estimate of intrinsic value well below the current price, indicating that Automatic Data Processing is overvalued at the present time.
Disclaimer: Â The author did not hold aÂ position in any company mentioned in this articleÂ at the time of publication and had no intention of changing that position within the next 72 hours. Â Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.