Automatic Data Processing's Earnings, Dividend Increase

Automatic Data Processing's (ADP, Financial) dividend increased by 8% with an overall yield above that of the Standard & Poor's 500 Index at 2.51%.

It is the nation's largest provider of business outsourcing, serving nearly 650,000 customers. The company was founded in 1949 and is a global company with customers in more than 100 countries.

The company operates in two units, the Employer Services and the Professional Employer Organizations. The Employer Services unit accounts for 75% of total revenue.

Automatic Data Processing is a consistent dividend payer, ranking 27th in yield within the large cap technology sector. The payroll firm announced financial results Wednesday, and Automatic Data Processing earned 86 cents per share for the quarter. The solid results bested analyst expectations of 76 cents per share.

Revenue was a solid $2.9 billion, also surpassing expectations. The firm's third-quarter revenue was 7.5% this year compared to the same quarter last year. The Employer Services Unit maintained solid growth of 6% while the faster growing, albeit smaller, Professional Employer Organization Unit had a 13% rise in total sales.

Management raised fiscal year 2017 to a range of $3.61 to $3.68 versus prior consensus of $3.62. Revenue guidance was set at about 8%, in line with 2016 growth. The firm broke down the projected revenue growth –Â 5% in the Employer Services Unit and a more robust 15% in the Professional Employer Organization segment.

Automatic Data Processing has maintained a solid three-year growth rate of dividends of 7%. The New Jersey-based company has paid dividends on a consecutive basis for 42 years, making the firm a Dividend Aristocrat. The quarterly dividend for the January payment will be 57 cents versus the prior-year rate of 53 cents per share. Automatic Data Processing does not qualify as a member of our Top 100 Dividend Stocks (see below).

The dividend will be paid at the new higher rate on Jan. 1, 2017, to shareholders of record at the close of business on Dec. 9. Automatic Data Processing is priced at $91.33. Listed in the table below are the quarterly dividend payments since 2010.

The ranking of Automatic Data Processing is based upon our five key criteria, which include:

Additional Information on price-sales (P/S) ratio and historical yield:

Final analysis

Positives

• ADP maintains a three-year dividend growth rate of 7%.
• ADP maintains a credit rating of AA. This is investment grade.
• ADP's dividend yield is above that of the S&P 500 Index.
• ADP has paid out a dividend consecutively for the past 42 years.
• ADP maintains a beta of 0.95, lower than the average company.
• ADP's Professional Employer Organization Unit maintains strong sales growth.

Negatives

• ADP's forward price-earnings (P/E) ratio is just over 24, well above that of the market.
• ADP's current dividend yield (2.51%) is below its five-year average historical dividend yield of 2.62%.
• ADP is trading at the top of its 10-year P/S historical range.

As the country's largest provider of payroll services, Automatic Data Processing will continue to benefit from serving smaller companies around the world. The compliance and regulatory issues alone make Automatic Data Processing a compelling choice for many small business owners. It maintains a wide base of customers –Â 650,000-plus relationships worldwide.

There is also the fact that once a business signs up with Automatic Data Processing, it is difficult to switch providers. Its annual client retention rate is more than 90%, and the firm has an average client tenure of about 11 years. It currently ranks No. 248 on the Fortune 500 list while generating more than $12 billion of revenue in fiscal 2016.

Automatic Data Processing focuses on midsized businesses with around 50 employees through its ADP Workforce Now® product. It also offers its ADP Vantage HCM now program for larger businesses. Much of Automatic Data Processing's growth each year comes simply from a growing numbers of employees in its system. As Automatic Data Processing charges a flat fee for service, additional fees are added as more employees join the program.

The better growing Professional Employer Organization model offers double-digit revenue growth potential for the company. It's different than the Employer Services Unit as it has employees assigned to Automatic Data Processing. Thus it is more of a dual contract arrangement for the employee. It is also a methodology for companies using Automatic Data Processing to offshore their human resources. Automatic Data Processing offers multiple other products associated with payroll including 401k administration and health care benefit plans to generate additional revenue.

On the negative side of the ledger, Automatic Data Processing's retention rate has been falling since 2013. It was 91.3 in 2013 and now resides at 90.5. Although retention rates stabilized in the low 90s for now, the firm has had multiple quarters of negative retention rates. Part of this could be due to the firm's efforts to move clients to its Workforce Now platform, which is cloud based.

Although Automatic Data Processing is one of the premiere companies within the technology sector, valuations are stretched. Based upon analyst expectations of $3.66 per share in earnings for 2017, Automatic Data Processing trades at a rich 25 times earnings. Compare that to the forward P/E ratio for the S&P 500, at 16.6. This P/E ratio is based on a forward 12-month S&P 500 EPS estimate ($130.76). Yes, Automatic Data Processing earnings and revenue growth are rising a consistent 15% and 7%, but it is also trading at 3.55 times revenue, much higher than the historical median and near all-time highs.

Based on its high forward P/E and elevated P/S along with a dividend yield below its historical average (2.62%), Automatic Data Processing is overvalued and does not qualify as a member of our Top 100 Dividend Stocks.

Disclosure: I have no position in Automatic Data Processing.

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