Quality rarely comes at a cheap price and the ADP dividend is no exception.
In fact, most high-quality dividend stocks hardly ever go on sale. And for me, the payroll and human resources services company, ADP, falls into the high-quality category.
So let’s work through an ADP dividend stock analysis. We will take a close look at ADP dividend growth, stock valuation, dividend safety, business fundamentals and much more!
ADP Company Background
Within the human resources and payroll functions, ADP offers a robust range of services and solutions. Some of them include:
- Payroll processing
- Time & attendance record keeping
- Talent management
- Employee benefits administration
- Consulting, outsourcing & technology integration
These services are provided to businesses of different sizes operating in a wide range of industries.
ADP operates in the same sector as Paychex. Paychex is another super high-quality company with outstanding dividend growth.
ADP Growth Strategy
ADP anticipates 7-9% long term revenue growth. The growth will come from the following areas:
- Cloud-based human capital management solutions – 4-5%
- Human resources outsourcing – 12-14%
- International expansion – 6-7%
ADP will combine its revenue growth initiatives with cost efficiencies from economies of scale and cost reduction programs. This combination of factors is expected to deliver double-digit percent annual earnings growth moving forward.
ADP Dividend Yield
ADP pays an annual forward dividend of $3.64 cents per share. This is a 2.1% ADP dividend yield at the recent ADP stock price.
ADP Dividend Growth Rate
|1 Year||3 Years||5 Years||7 Years|
There are a number of great aspects regarding ADP dividend growth.
First of all, during the 4th quarter of 2019, ADP announced another more than 15% dividend increase.
Furthermore, I see an excellent long term track record of dividend increases as shown in the chart above.
And finally, there has been an acceleration of dividend growth in recent years.
For me, there is nothing like a good dividend growth stock to boost an investor’s passive income from dividends! And from my perspective, ADP has an awesome track record of rewarding shareholders with dividend increases.
ADP Consecutive Years Dividend Growth
ADP has increased it’s dividend annually for 45 consecutive years.
This record makes ADP a Dividend Aristocrat. Dividend Aristocrats are companies that have increased their dividend for at least 25 years in a row.
ADP Dividend Policy
I like it when a company clearly communicates its objectives for dividend payments. Many companies choose not to do this, but ADP has delivered for us in this area.
According to the presentation from their 4th quarter of 2019 earnings release, ADP is targeting a 55% – 60% dividend payout ratio.
More on the dividend payout ratio in a moment. Let’s check out revenue growth next.
Growing dividends come from growing earnings and growing earnings partially come from growing revenues.
ADP Revenue Trend
Revenue growth has been steady as shown in the chart above. It is generated from 3 main segments:
- Professional employer organization
- Employer services
- Interest on client funds
First of all, revenue has accelerated due to ADP’s Professional Employer Organization (PEO) segment. This segment provides comprehensive HR solutions for small and mid-size businesses.
Furthermore, revenue comes from its more traditional employer services segment. This segment includes payroll processing.
Employer services represent the largest segment but it grows slowly. This segment increases revenues mainly by adding new clients to its customer list.
Finally, ADP also makes revenue from interest earned on payroll funds deposited by their clients. This is due to the period of time between when a client deposits its money for payroll with ADP and when employees actually receive the money.
The break out of revenue from each of these 3 segments is shown in the chart below.
ADP Dividend, Earnings & Payout Ratio
Earnings growth has been substantial, nearly doubling in the last 6 years. ADP has benefited from a strong US economy and full employment in recent years. And the dividend has grown right along with earnings.
The ADP dividend payout ratio has been running in the 55%-58% range in recent years. This performance is consistent with ADP’s dividend policy statement mentioned previously.
A lower dividend payout ratio is generally better. It shows the company has ample room to raise the dividend in the coming years. Or, withstand an earnings drop without having to reduce the dividend.
ADP Free Cash Flow
Dividends are paid from cash, not accounting earnings. So, I make a practice of cross-checking dividend payments against free cash flow.
As a service business, ADP’s capital investment needs are minimal when compared to other dividend-paying companies. So, the dividend payout ratio as a percent of free cash flow is even lower than as a percentage of accounting earnings.
As shown in the chart above, dividend payments consume only 50% of free cash flow.
ADP states in its recent investor presentation, the following priorities for cash:
- Invest in the business for organic revenue growth and margin expansion
- Invest in acquisitions to supplement existing capabilities and strategy
- Return cash to shareholders through dividends and share repurchases
In looking through ADP’s most recent annual report, item 3 (dividends and share repurchases) consume most of the available cash. And, as a shareholder, that is fine by me.
ADP Credit Rating
Knowing a company’s credit rating is important. A corporation’s credit rating is similar to how your personal credit score works.
Higher credit ratings mean lower risk to those who lend the company money. Also, higher credit ratings mean lenders are more likely to get their loans paid back.
ADP has an excellent credit rating. It is rated AA and Aa3 by S&P and Moody’s, respectively. This represents an investment grade, very low credit risk assessment.
ADP’s credit ratings are some of the highest you can find. Only 2 US companies have the highest, AAA credit rating. You can read my reviews about them by following the links below:
ADP also had the highest AAA credit rating as recently as 2014. But, was downgraded after they spun off the dealer services business known as CDK Global.
CDK Global provides software and technology solutions for automotive retailers. It now trades and operates as a separate company.
ADP Financial Position
With such an outstanding credit rating, it comes as no surprise to me that ADP’s financial position is very strong. I judge a company’s financial position based on its capital structure.
Specifically, I do not like to see large amounts of debt on the balance sheet. Debt repayment can be a threat to dividend safety if a business experiences financial difficulties.
ADP’s debt to equity ratio is a very low .37 to 1. And, the company has cash on its balance sheet nearly equal to its total debt. In my opinion, ADP has a rock-solid balance sheet.
ADP Dividend Safety
ADP’s dividend gets very high marks for safety.
In my opinion, there is little to no chance of the ADP dividend being reduced anytime in the foreseeable future. I base my evaluation of dividend safety on ADP’s:
- Excellent business fundamentals
- Reasonable dividend payout ratios
- High credit ratings
- Strong balance sheet
ADP Dividend Growth Projection
For income planning purposes, I make a dividend growth projection for each of my holdings. I base this projection on
- Historical dividend growth
- Dividend payout ratios
- Stated dividend policy when management provides one
- Business fundamentals
- Growth strategy
ADP is forecasting 14.5% – 17.5% earnings growth through its fiscal year 2021. And, I expect them to hold their dividend payout ratio constant. So, this would suggest about 15% annual dividend growth.
Certainly, 15% dividend growth is possible over the next 1-2 years. On the other hand, I expect long-term dividend growth to be significantly lower. Why? ADP’s business is heavily influenced by economic conditions.
So, a global recession would likely put a lid on earnings and dividend growth. I have no idea when the next recession will happen. But we will have another one someday, I’m quite sure. And, I expect it will temporarily slow ADP dividend growth.
So, over the long term, I am forecasting ADP dividend growth to be 7-9% annually. If ADP is able to deliver higher dividend growth, I will be very happy. But, I am not going to count on it.
ADP Stock Valuation
Let’s look at a few different valuation measures to judge ADP’s stock price.
ADP Dividend Discount Model
The single-stage dividend discount model takes into account several factors I have discussed thus far.
- Current annual dividend payment $3.64
- Projected annual dividend growth – 8%
- My desired annual rate of return – 10%
Using these assumptions, the constant growth model calculates the fair value of ADP stock to be $197 per share.
ADP Stock Price To Earnings Ratio
Unfortunately, ADP’s stock price is very expensive on a price to earnings basis.
Even with substantial earnings growth forecasted for the fiscal year 2020, ADP stock looks expensive. The forward price to earnings ratio still stands near 30 times.
As a comparison, the S&P 500 trades at about 18 times forward earnings. It is interesting to note that ADP’s smaller competitor, Paychex, also carries a similarly high price to earnings ratio.
Morningstar Fair Value
The investment analysis firm Morningstar places the fair value of ADP stock at $134 per share.
Stock Valuation Conclusions
Only the dividend discount model judges ADP stock to be a buy at current prices. Why? The dividend discount model places a high value on the future dividend growth.
On the other hand, both the price to earnings ratio and Morningstar suggest ADP stock is significantly overvalued.
ADP Stock Dividend Analysis Summary & Wrap Up
I have been very fortunate to own ADP for about 10 years. It holds a mid-size position in my dividend stock portfolio built mostly in 2010 through 2012.
The company’s business fundamentals are very solid. However, ADP will be negatively impacted by the next recession if and when the economy contracts.
The company’s historical dividend growth has been excellent. Furthermore, future dividend growth should also be strong. And finally, the dividend appears to be very safe from any potential reduction.
In my opinion, ADP is a great dividend growth stock to buy and own for the long term. I would love to buy more on any price weakness. Even without a drop in the share price, I may look to make small incremental purchases overtime.
As I said at the beginning, high quality rarely comes at a cheap price. Rather than waiting for better prices, I like ADP stock as a candidate for small incremental purchases over the long run.
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