The stock of Automatic Data Processing (NAS:ADP, 30-year Financials) is estimated to be modestly overvalued, according to GuruFocus Value calculation. GuruFocus Value is GuruFocus’ estimate of the fair value at which the stock should be traded. It is calculated based on the historical multiples that the stock has traded at, the past business growth and analyst estimates of future business performance. If the price of a stock is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher. At its current price of $205.6 per share and the market cap of $87.5 billion, Automatic Data Processing stock gives every indication of being modestly overvalued. GF Value for Automatic Data Processing is shown in the chart below.
Because Automatic Data Processing is relatively overvalued, the long-term return of its stock is likely to be lower than its business growth, which averaged 7.1% over the past three years and is estimated to grow 3.67% annually over the next three to five years.
Since investing in companies with low financial strength could result in permanent capital loss, investors must carefully review a company’s financial strength before deciding whether to buy shares. Looking at the cash-to-debt ratio and interest coverage can give a good initial perspective on the company’s financial strength. Automatic Data Processing has a cash-to-debt ratio of 0.80, which ranks in the middle range of the companies in Business Services industry. Based on this, GuruFocus ranks Automatic Data Processing’s financial strength as 5 out of 10, suggesting fair balance sheet. This is the debt and cash of Automatic Data Processing over the past years:
It poses less risk to invest in profitable companies, especially those that have demonstrated consistent profitability over the long term. A company with high profit margins is also typically a safer investment than one with low profit margins. Automatic Data Processing has been profitable 10 over the past 10 years. Over the past twelve months, the company had a revenue of $14.6 billion and earnings of $5.77 a share. Its operating margin is 21.70%, which ranks better than 90% of the companies in Business Services industry. Overall, GuruFocus ranks the profitability of Automatic Data Processing at 8 out of 10, which indicates strong profitability. This is the revenue and net income of Automatic Data Processing over the past years:
Growth is probably one of the most important factors in the valuation of a company. GuruFocus’ research has found that growth is closely correlated with the long-term performance of a company’s stock. If a company’s business is growing, the company usually creates value for its shareholders, especially if the growth is profitable. Likewise, if a company’s revenue and earnings are declining, the value of the company will decrease. Automatic Data Processing’s 3-year average revenue growth rate is better than 68% of the companies in Business Services industry. Automatic Data Processing’s 3-year average EBITDA growth rate is 9.2%, which ranks in the middle range of the companies in Business Services industry.
Another way to evaluate a company’s profitability is to compare its return on invested capital (ROIC) to its weighted cost of capital (WACC). Return on invested capital (ROIC) measures how well a company generates cash flow relative to the capital it has invested in its business. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. If the ROIC is higher than the WACC, it indicates that the company is creating value for shareholders. Over the past 12 months, Automatic Data Processing’s ROIC was 5.98, while its WACC came in at 5.28. The historical ROIC vs WACC comparison of Automatic Data Processing is shown below:
In closing, the stock of Automatic Data Processing (NAS:ADP, 30-year Financials) shows every sign of being modestly overvalued. The company’s financial condition is fair and its profitability is strong. Its growth ranks in the middle range of the companies in Business Services industry. To learn more about Automatic Data Processing stock, you can check out its 30-year Financials here.
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