To become a Dividend King, a company must raise its dividend for at least 50 consecutive years. Attaining this singular criteria for entry into this index sounds easy in theory, but just 48 companies currently hold the title of Dividend King.
Automatic Data Processing Inc. (ADP, Financial) has not yet qualified for membership in this exclusive group, but the company did raise its dividend by 20.2% for the Jan. 1, 2023 payment date.
Assuming the dividend stays constant for all of 2023, Automatic Data Processing will have amassed a dividend growth streak of 48 consecutive years, putting it that much closer to being enshrined in the Dividend Kings.
But Automatic Data Processing is much more than just a dividend growth story. The company’s business model, size and scale have positioned it to be able to successfully grow its dividend, along with its results, for a long period of time.
Let’s dig deeper to see why I believe investors should see the dividend increase as a positive sign for the company and its stock.
Takeaways from recent earnings results
Automatic Data Processing reported fiscal first-quarter 2023 results on Oct. 26. Revenue grew 10% to $4.22 billion, which was $53 million more than the market had expected. Adjusted earnings per share of $1.86 were higher by 21 cents, or 12.7%, from the prior year and 7 cents more than anticipated.
Looking closer at the two segments of the company, revenue for Employer Services, which provides payroll and other administrative services, grew 9% in constant currency to $2.79 billion. This segment was powered by average client funds balances growth of 9%, with interest revenue seeing a tailwind from the rising interest rate environment.
Employer Services also saw its U.S. pays under control grow 6% year over year. The segment benefited from the addition of new clients as well as an increase in the number of transactions with existing customers. Revenue retention reached a new record for the quarter, while the segment margin expanded 50 basis points to 30.9%.
PEO Services, which offers a suite of human resources outsourcing solutions, grew 13% to $1.43 billion. Average worksite employees increased 12% to 704,000, a continuation of the high growth rates seen over the past few quarters. This metric is likely to continue to rise as bookings have been very strong. Segment margins expanded 80 basis points to 16.1%.
Following earnings results, Automatic Data Processing updated its guidance for fiscal year 2023. Revenue is now projected to increase 8% to 9%, up from 7% to 9% previously, while adjusted earnings per share are expected to grow 15% to 17%, up from 13% to 16%.
Impressive growth rates have long been the norm for the company. Consider revenue and net income growth over the past decade:
From 2013 onward, you can see that revenue has improved almost at regular intervals. Same for net income.
Yes, this growth has come primarily during an economic expansion. And some might argu the company’s business results would falter during a recession as employers cut positions, but this has not been the case.
Automatic Data Processing saw earnings per share grow almost 31% from 2007 to 2009. More recently, earnings per share gained 8.8% in 2020 even as Covid-19 negatively impacted the economy.
Some of this improvement is due to Automatic Data Processing’s aggressive share repurchases, but net income still improved more than 22% from 2007 to 2009 and nearly 8% in 2020. Clearly, a difficult labor market has not made that much of a dent on the company’s revenue and earnings per share results.
The last 10 fiscal years have seen revenue grow by 4.3% annually. Earnings per share have a compound annual growth rate of 10.7%, driven in part by share repurchases and a 580-basis point expansion in net margin to 17.9%.
Results like these over the long term is why Automatic Data Processing has a GF Score of 91 out of 100, which implies the likelihood of outperformance going forward. The company’s high score is due to perfect or near-perfect rankings for growth, profitability and momentum. Automatic Data Processing does receive a middling score on financial strength and a low score for value.
Valuation and dividend analysis
One reason the stock might be trading with a premium multiple is that Automatic Data Processing has performed well over the last year, with the stock returning more than 11% during this period of time.
This compares favorably to the 16% drop in the S&P 500 Index and especially well to the 41.5% decline in the information technology industry.
The low score for value is due to the premium multiple that Automatic Data Processing currently trades with. Using the midpoint of earnings guidance, the company expects to earn $8.12 per share in fiscal year 2023. With the stock trading at $258 today, the forward multiple is nearly 32 times earnings.
Given the business success and dividend growth streak, I firmly believe a premium multiple is warranted. That said, the forward multiple is elevated against the five- and 10-year price-earnings ratios of 29.2 and 27.5.
Automatic Data Processing is trading above its GF Value as well.
With a GF Value of $230.34, Automatic Data Processing has a price-to-GF Value ratio of 1.12, earning the stock a rating of modestly overvalued from GuruFocus based on its historical ratios, past financial performance and analysts' future earnings projections.
Final thoughts
Automatic Data Processing has a lengthy history of growth, both during economic expansions and contractions. The most recent quarter speaks to the strength of the company, as does the revised guidance for the fiscal year.
As a result of long-term success, Automatic Data Processing has a very long dividend growth streak and is now just two years away from becoming a member of the Dividend Kings.
The recent dividend increase of more than 20% is twice the 10-year compound annual growth rate of 10% and is reflective of the company’s highly successful business model.
Shares are not cheap, but Automatic Data Processing’s history of earnings and dividend growth have warranted the premium valuation in my opinion. Investors looking for a company with proven track record of revenue, earnings and dividend growth should consider adding Automatic Data Processing to their watchlist.
